
Copyright N?. 



C?i3F£R!GHT DEPOSm 



THE THEORY OF 

EARNED AND UNEARNED 

INCOMES 



THE THEORY OF 



EARNED AND UNEARNED 
INCOMES 



A STUDY OF 

THE ECONOMIC LAWS OF DISTRIBUTION 

WITH SOME OF THEIR APPLICATIONS TO SOCIAL 

POLICY 



BY 

HARRY GUNNISON BROWN 

PROFESSOR OF ECONOMICS IN THE UNIVERSITY OF MISSOURI 



Author of 
'Principles of Commerce' 



dolumbta. MXnaatxtX 

MISSOURI BOOK COMPANY 

1918 



/ j:.-- 



6d/ 



Copyright, 1918 

By Missouri Book Company 

Published September, 1918. 



OCT 21 i91'8 



Press of , 
E. W- Stephens Publishing Co. 
Columbia, Missouri. 



yCi.A5l)3909 



PREFACE 

The study here offered is intended to appeal to 
several classes of readers. My hope is that it will 
be read by, among others, socialists of the Marxian 
school, single taxers, and economists. For those 
orthodox or Marxian socialists who are willing to 
reexamine the theoretical foundations of their doc- 
trines, interest will attach to the classification of 
incomes and to the attempt to distinguish between 
incomes which are earned and incomes which are 
unearned. The Marxian view that all income from 
property is ''surplus value" and represents exploita- 
tion, is not accepted, but it is made clear that some 
income from property — as, indeed, from labor also 
— is unearned. To single taxers the discussion, in 
Chapter VI, of land rent and its taxation will per- 
haps be of chief interest, but the rest of the book 
leads up to and supplements the chapter on land 
rent in a way to make the whole study significant 
for this class of readers. I venture to hope, also, 
that professional economists, as such, will find 
enough of critical and constructive material in the 
text and footnotes, to make the study of interest 
to them. Finally, the book is intended to make an 
appeal to serious readers of no particular school or 
of any school of thought and of any business or 
profession, v/ho are concerned with the evils in our 
present economic system and who look forward to 
worth-while changes during or after the war. 
World-wide democracy will be but half achieved if 
it be achieved in the political realm only, with no 
accompanying economic changes. 

v 



VI Preface 

I am under obligation to the Quarterly Journal 
of Economics for permission to republish, sub- 
stantially without change, the major part of an 
article on 'The Marginal Productivity versus the 
Impatience Theory of Interest," first published in 
August, 1913. To the American Economic Review 
I am indebted for permission to use, also in Chap- 
ter IV, most of an article on 'The Discount versus 
the Cost-of-Production Theory of Capital Valua- 
tion," originally published in June, 1914. To the 
Journal of Political Economy I am indebted for 
permission to republish, in Chapter VI, along with 
later additions, an article on "The Ethics of Land- 
Value Taxation," which appeared in May, 1917. 
The Macmillan Company have kindly consented to 
the use in Chapter I of this book, of about eight 
pages taken from the first two Chapters of my 
Principles of Commerce, published by them. Pro- 
fessor H. J. Davenport of Cornell University has 
given the manuscript a conscientious and critical 
overhauling and although I have not been able to 
accept all of his suggestions, the book has been im- 
proved because of his criticisms. To my wife I 
owe thanks for a careful and critical reading of the 
entire manuscript and for reading the proof. 

Harry Gunnison Brown 
Columbia, Mo. 
May, 1918. 



SUGGESTIONS TO READERS 

To the general reader whose time or patience 
may not permit his following the more difficult 
parts of the argument set forth in the succeeding 
pages but who nevertheless seeks an understanding 
of the principal practical conclusions reached, it is 
suggested that Chapters I, II and IV (but not the 
Introduction) be entirely omitted, along with the 
critical footnote discussions in the other chapters. 
But Chapter IV cannot fairly be omitted by the 
reader who, familiar with the controversial liter- 
ature on the theory of the interest rate, has tenta- 
tively adopted a conclusion in disagreement with 
that presented herein. Nor, indeed, should the 
critically-minded reader fail to glance at the foot- 
notes, since these are inserted in many cases for 
the express purpose of meeting anticipated 
criticisms. 



VII 



SUMMARY OF CHAPTER TOPICS 

INTRODUCTION— THE POINT OF VIEW. 

CHAPTER I. THE DETERMINATION OF VALUE. 

CHAPTER II. ULTIMATE DETERMINANTS OF VALUE. 

CHAPTER III. THE CAUSES OF INTEREST. 

CHAPTER IV. THE RATE OF INTEREST. 

CHAPTER V. WAGES AND POPULATION. 

CHAPTER VI. THE RENT OF LAND AND ITS TAXATION. 



VIII 



CONTENTS BY SECTIONS 

Introduction. 

THE POINT OF VIEW 3-4 

CHAPTER I. 
THE DETERMINATION OF VALUE 5-45 

§ I Value, or the Analogue of Value, to the Isolated Man. 

§ 2 Conditions Determining the Extent of an Isolated Man's Pro- 
duction- 

§ 3 Utility, Relative Production of Different Goods, and Value, 
in a Modern Community. 

§ 4 Demand and Supply in Relation to Price. 

§ 5 Explanations and Qualifications. 

§ 6 Speculation in Relation to Price. 

§ 7 The Determination of the General Level of Prices. 

§ 8 The Relation of Commercial Banking to the General Level of 
Prices. 

§ 9 Summary. 

CHAPTER II. 
ULTIMATE DETERMINANTS OF VALUE 46-75 

§ I Supply of One Good Means Demand for Other Goods. 

§ 2 Influences Back of Demand. 

§ 3 Influences Back of Supply. 

§ 4 Labor Costs in Production. 

§ 5 Land and Capital Costs in Production. 

§ 6 The Value of Land. 

§ 7 Joint Demand and Joint Supply. 

§ 8 Summary. 

CHAPTER HI. 
THE CAUSES OF INTEREST 76-111 

§ I The Factors of Production. 
§ 2 The Accumulation of Capital. 

IX 



X Contents by Sections 

§ 3 The Productivity of Capital. 

§ 4 Capital Accumulation versus Marginal Capital Productiveness. 

§ 5 Saving or Abstinence in Relation to Interest. 

§ 6 Summary. 

CHAPTER IV. 

THE RATE OF INTEREST 112-170 

§ I The Choices of a Crusoe- 

§ 2 The Demand for Present Goods. 

§ 3 The Supply of Present Goods Offered for Future Goods. 

§4 Demand for and Supply of Present Goods Further Considered. 

§ 5 A Concrete Illustration. 

§ 6 Interest in a Money Economy. 

§ 7 Changing Bank Reserves in Relation to Interest. 

§ 8 Rising and Falling Prices in Relation to Interest. 

§ 9 Some Further Complications in the Actual Industrial World. 

§ lo Interest Earned and Unearned. 

§11 Summary. 

CHAPTER \^. 

WAGES AND POPULATION 171-198 

§ 1 The Proximate Determination of Wages. 

§ 2 Influence of Physical and Influence of Value Productivity en 

Wages. 
§ 3 Comparative Wages in Different Labor Groups. 
§ 4 A Side Light on the Interest Problem. 
§ 5 General Wages and Population. 
§ 6 Immigration and Wages. 
§ 7 Summary. 

CHAPTER VI. 

THE RENT OF LAND AND ITS TAXATION 199-254 

§ I Land Rent as a Marginal Product of Land. 

§ 2 Land Rent versus Capital Interest. 

§ 3 Land Rent as an Unearned Income. 

§ 4 Improvements by Special Assessments and the Right of Land- 
owners to a Rental Return. 

§ 5 Other Services of City Landowners. 

§ 6 The Increment of Land Values in Relation to the Settlement 
of the American West. 



Contents by Sections xi 

§ 7 Ownership of Land by omall-Family Groups versus Increas- 
ing Population in Other Groups. 

§ 8 The Bearing of the Contention that there mgy be Other Un- 
earned Increments not Especially Associated with Land. 

§ 9 The Taxation of Future Increments of Value. 

§ lo Land-Value Taxation in Relation to the Theory of Vested 
Rights, 

§ II A Few Additional Considerations. 

§ 12 Summary. 



THE THEORY OF 

EARNED AND UNEARNED 

INCOMES 



Briefly, then, the universal basis of co-operation is the proportion- 
ing of benefits received to services rendered. 

Herbert Spencer 

He who by any exertion of mind or body adds to the aggregate 
of enjoyable wealth, increases the sum of human knowledge or gives 
to human life higher elevation or greater fullness — he is in the 
large meaning of the words, a "producer," a "workingman," a "la- 
borer," and is honestly earning honest wages. But he who without 
doing aught to make mankind richer, v/iser, better, happier, lives 
on the toil of others — he, no matter by what name of honor he may 
be called, or how lustily the priests of Mammon may swing their 
censers before him, is in the last analysis but a beggarman or a 
thief. 

Henry George 



(2) 



THE THEORY OF 
EARNED AND UNEARNED INCOMES 



INTRODUCTION 

THE POINT OF VIEW 

The science of economics may be pursued, as 
may any science, purely for its own sake. Its 
pursuit may be an intellectual amusement of the 
cultured, and the contemplation of its conclusions 
may be enjoyed by its votaries as one would enjoy 
a great epic. But the study of economics may 
also furnish guidance in matters of social policy 
and may thus serve two ends of which the second 
is probably by far the more important. 

In attempting, through the succeeding pages, to 
outline a theory of earned and unearned incomes, 
we shall not be able to lose sight of this second 
end. We shall, indeed, be continually inquiring 
how economic forces work, e. g., what influences 
fix value and price, what are the conditions which 
cause interest to be paid, how interest rates are 
determined, what conditions fix wages, what 
influences make land rent rise or fall. But 
back of our search for these scientific laws there 
will lie a purpose and a point of view. The 
purpose will be to find out those things in the 
theory of income distribution the knowledge of 
which may help us to the fairest possible economic 
organization of society. The point of view will be 
some notion as to what tests determine whether an 
income is earned or not and some sort of ideal 

(3) 



4 Earned and Unearned Incomes 

regarding the desirability of permitting individuals 
to enjoy incomes which are not earned. With 
certain qualifications which will become clear as 
our investigation proceeds, we shall regard in- 
comes as earned when equivalent service is given 
by their recipients to those from whom the incomes 
are ultimately drawn; and we shall regard incomes 
as unearned when their recipients enjoy them 
without making a corresponding return. 

Whether such a distinction has any significance 
for any individual reader, will depend much on 
his ethical viewpoint, his general social philosophy. 
To one who regards absolute equality of incomes 
as the economic ideal, however great the differences 
in efficiency, an investigation into the question 
whether various incomes are earned or not, will 
seem irrelevant. Likewise, to one who regards 
the existence of privileged classes drawing large 
incomes, as a desirable condition of economic and 
social life, there will be little significance in a 
conclusion that many of these large incomes are 
wholly or partly unearned. But there are persons 
who believe, more or less on utilitarian grounds, 
that economic society is not well organized unless 
incomes have some reasonable relation to service 
rendered by the recipients to those from whom 
the incomes are in the last analysis, received, 
and that no class of citizens (unless by way of 
charitable relief) should be privileged to receive 
incomes not based on such service. To persons who 
hold this view, an analysis of incomes which leads 
eventually to their classification as earned and un- 
earned may seem in very truth to constitute the 
first step of an inquiry into the nature and possi- 
bility of economic democracy. 



CHAPTER I 

THE DETERMINATION OF VALUE 

§ 1 
Value, or the Analogue of Value, to the Isolated 

Man 

By value, in the sense of value in exchange, we 
ordinarily mean the number of units of some other 
good or goods, taken as a standard or measure of 
values that any given article or immaterial benefit 
will bring in trade. Thus, the value of a man's horse 
may be 150 bushels of wheat or 30 tons of coal or 
75 days of common labor or two dozen operatic per- 
formances. The thought is that the horse would sell 
for — would bring in exchange — such an amount of 
other goods. Since money is the medium by which 
exchanges are commonly effected and, therefore, a 
generally recognized measure of value, we ordinarily 
express exchange relations in terms of money. We 
would be much more likely to state the value of the 
horse as $160 than to state it as (for example) 30 
tons of coal. Everyone sells goods for money or 
buys goods with money or both. Everyone is toler- 
ably familiar with the value of the money unit in 
terms of various other goods. Everyone knows, that 
is, about how much of various other goods a dollar 
will buy. Consequently the statement that a horse 
is worth $160 includes the other statements and 
can be readily translated into them. Valuation of 

1 Jevons, The Theory of Political Economy^ fourth edition, London 
(Macmillan), 1911, pp- 78-83. 

(5) 



6 Earned and Unearned Incomes 

goods in terms of money is really valuation of them 
in terms of goods-in-general. 

Exchange value is a social phenomenon. It in- 
volves the exchanging of one kind of goods for 
another kind (or kinds) of goods and a comparison 
of the utility or desirability of the one kind with 
that of the other. Such a comparison will presuma- 
bly be made, in fact, by both parties to an exchange. 
But though exchange value is thus a phenomenon 
involving human relations as well as involving 
goods and so is a social phenomenon, nevertheless 
nearly all of the factors that enter into its deter- 
mination exist in a state of isolation such as that 
of a Robinson Crusoe. And so we may, perhaps, 
with advantage, begin our study of value by a 
consideration of the comparisons that might enter 
the mind of a Crusoe who, alone on his island, is 
engaged in eking out a precarious living. To 
Crusoe, as to a man in the most advanced modern 
community, must be presented frequently the 
necessity of making a choice among different 
commodities, all of which together he can not 
secure in anything like the number or quantity 
desired, and all of which, possibly, he cannot use, 
since some may be substitutes for others. He must, 
therefore, compare the utility of one kind of 
goods with the utility of something else. It may 
be that he has occasion to decide whether a month's 
labor which he can spare from other purposes 
shall be used to build an additional room to his 
hut or dugout, or whether it shall be used to make 
him a canoe; whether today's efforts shall be 
devoted to killing and dressing a goat or whether 
the day shall be spent in catching fish. There is, 



The Determination of Value. 7 

of course, for Crusoe, no value in the sense of 
power in exchange, since there is no one with 
whom exchanges can be made. But there is value, 
if we may use the term in an analogous case, in 
the sense of comparison of one thing with some 
other thing or things, i. e. there is comparative 
utility. If Crusoe would rather spend a month's 
labor which he has available, in building an ad- 
ditional room than in constructing a canoe, it is 
probably because the utility of the room is greater 
to him than the utility of the canoe, or, at any 
rate, that he believes it to be greater. If he 
could make the canoe in two weeks and a new 
goat-skin suit in another two weeks but would 
rather devote all four weeks to building the 
additional room, then the room has greater utility 
to him than the canoe and suit together; or, if 
the canoe and suit are reckoned equal, the room 
has more than twice the utility of either. Were 
Crusoe in a small community with several other 
inhabitants, he would perhaps be willing to make 
two canoes for two of his fellow islanders, in 
return for their building the additional room for 
him. Then we could say that the value of the 
room was two canoes or that a canoe was worth 
the half completed room. Crusoe, alone on his 
island, can make no trade; but he can appraise 
the room in terms of canoes and clothes to the 
extent of deciding whether he will produce the 
one or the other two. Similar comparisons would 
be made in the case of goods satisfying somewhat 
the same need. For a quart of berries, Crusoe 
might be willing to work two hours and for a 
boiled lobster two hours. Then the lobster would 



8 Earned and Unearned Incomes. 

be worth, to Crusoe, two quarts of berries. Each 
article can be compared with each other, directly 
or through the common means of purchasing them 
all from nature, viz. labor.^ 

We have now to take into consideration another 
fact, so far not mentioned. This is that successive 
units of any article or service have a progressively 
lower degree of utility. Crusoe's one suit of goat 
skin, if he can afford no more, will have great 
utility to him, will be, in fact, indispensable. A 
second suit will be, perhaps, important but not as 
much so. A third will be comparatively unim- 
portant. Similarly, a one-room shelter will be 
indispensable; a second room may be almost 
indispensable; a third will be a great convenience, 
a fourth somewhat convenient, and so on. It is 
certain that Crusoe will get himself enough food to 
support life, if he possibly can. It is pretty certain 
that he will build and keep in some repair one room. 
It is pretty certain that he will keep himself sup- 
plied with one suit of clothes. How much beyond 
these essentials he will go will depend upon his 
intensity of desire for comforts and luxuries and 
also upon his strength, energy and willingness to 
work. 

Having seen that the utility of any good dimin- 
ishes for Crusoe according as he has a large amount 
of that good, let us reexamine our conclusion re- 
garding the utility to him of a room as compared 
with that of a canoe. The comparative utilities of 
these two items of wealth will depend on how 
much room Crusoe already has as well as upon his 

2 Or labor and waiting. See Chapters III and IV. 



The Determination of Value. 9 

need for room in general or for a canoe. If he 
has no room at all, a one-room hut will probably 
seem much more important to him than a canoe, 
and, rather than go without it, he might be willing 
to do much more work than he would do for a 
small boat. But the utility of a second room 
would be less and that of a third still less. Suppose 
Crusoe would as soon have a canoe as to have the 
third room. Then he would be willing to devote as 
much labor to getting the one as to securing the 
other. If the time necessary to build an additional 
room is four weeks and that necessary to make a 
canoe is two weeks, he would choose the canoe after 
he had a sufficient number of rooms so that an 
additional room would have less than twice the 
(marginal) utility of a canoe. If, that is, the labor 
of building a room remains always twice that of 
making a canoe, regardless of the number of 
rooms added, then this labor cost determines the 
number of rooms which Crusoe will build in 
preference to a canoe and, therefore, the marginal 
utility of a room (the utility of the last, final or 
marginal room). The value of a room in terms 
of canoes will depend upon the utility of an ad- 
ditional room, but this utility will depend upon 
the number of rooms Crusoe already has and this, 
again, will depend upon the labor required to 
build a room. 

But suppose that the nearby available material 
for house building is scarce, that additional rooms 
necessitate longer trips for materials, and, perhaps, 
greater search to find materials that are satis- 
factory, — in other words, that the labor of con- 
structing additional rooms becomes progressively 



10 Earned and Unearned Incomes. 

greater as more rooms are built. Then the labor 
of construction no more determines the utility and 
value of a room than its utility and value deter- 
mine the amount of labor which Crusoe will 
undergo to build it. For if the utility of additional 
rooms to Crusoe is little, he will construct but one 
or two rooms and the labor of construction will be 
slight; whereas, if the utility of additional rooms 
is great, he will build them, in preference to a 
canoe, until the labor of construction (per added 
room) is considerable. Nevertheless it will still 
be true that when the utility of an additional 
room becomes less in relation to the labor of con- 
struction than is the utility of a canoe in relation 
to the labor of its construction, Crusoe will 
cease adding rooms and will turn to the building 
of a canoe. And the value of a room will still be 
measured by its utility in relation to the utility 
of a canoe, or by the labor of its construction in 
relation to the labor of constructing a canoe. 
Either method of measurement is correct since 
either is equivalent^ to the other. 

§ 2 

Conditions Determining The Extent of An Isolated 
Man's Production 

Having considered the principles determining 
the relative amounts of different goods that an 
isolated man will produce, and the values or the 
comparative utilities of these goods,* we may now 
profitably give brief attention to the considera- 

" At the margin. 

* See, however, the further considerations in Chapter IV, § i. 



The Determination of Value. 11 

tions determining the total amount of such a man's 
production. Of course Crusoe will produce neces- 
sary food. It is scarcely less certain that he will 
make himself some clothing and get at least a 
crude kind of shelter. His different wants will 
receive satisfaction in the order of and to the 
extent commensurate with their importance and 
the ease with which they can be satisfied. The 
wants remaining unsatisfied will be of progressive- 
ly less importance in relation to the effort or other 
sacrifice necessary to satisfy them. On the other 
hand, additional hours of labor per day soon come 
to involve discomfort and sacrifice to an increasing 
degree. If Crusoe works thirteen hours, he will 
almost certainly find the thirteenth hour of labor 
harder than the tenth, eleventh or twelfth. He 
will choose to work eight, ten, twelve or thirteen 
hours as the case may be, according to the relation 
between the utility to him of the goods which the 
last hour's work produces and the disutility 
(discomfort or labor sacrifice) of the last hour's 
work. If the importance to him of the goods 
which his tenth hour produces is more than enough 
to compensate him for the work done, then he will 
work ten hours. Or, perhaps, at nine hours and 
three-quarters the last minute's work just balances 
in sacrifice the gains to be secured. Then it will 
be a matter of indifference to him whether he 
works nine hours and forty-four minutes or nine 
hours and forty-five minutes, but he will not work 
nine hours and forty-six minutes.^ 

5 See Jevons, The Theory of Political Economy, fourth edition, 
P- 173- 



12 Earned and Unearned Incomes. 

§ 3 

Utility, Relative Production of Different Goods, 
and Value, in a Modern Community 

We have seen how an isolated man compares 
the utility of different objects and what considera- 
tions determine the amounts of them that he will 
produce. Let us now consider how values are 
determined in a community of persons, where 
there is division of labor and where, therefore, 
exchange of goods is a characteristic feature of 
economic life. In general, and with a qualification 
which will be made shortly,^ an isolated group of 
producers, or an entire community isolated from 
other communities, or society as a whole, produces 
to a larger degree those things of which its mem- 
bers desire large amounts, provided the sacrifice 
or cost of production is no greater, and produces 
to a less extent goods not so much desired. Suppose, 
for instance, that we are considering a community 
whose members desire large amounts of bread 
and, therefore, wheat, but only a small quantity of 
apples. Then large amounts of wheat will be 
produced and not many apples. But since the 
producers of wheat and of apples do not consume 
most of their own production, their relative tastes 
and preferences as between these two kinds of 
goods can not, to any large extent, act upon them 
directly. It is the tastes and preferences of buyers 
which affect price by influencing demand. Thus 
the large general demand for wheat means that 
there are many persons willing to pay a good 

^ See second and third paragraphs after this. 



The Determination of Value. 13 

price for it rather than not to have it or rather 
than to have less of it, that the amounts these 
persons are willing to purchase can only be 
produced by the labor of many wheat raisers, and 
that the prices which the consuming purchasers 
are willing to pay are such as will make many 
persons willing to engage in (and devote their 
land to) wheat production. On the other hand, to 
say that apples are not greatly desired is to say 
that, unless the price is very low, there are few 
persons who want any or that those who want 
them want but small amounts, or both. It follows 
that large amounts can not be sold at a remuner- 
ative price and that the price consumers will pay 
is only high enough to keep a comparatively few 
producers (and few acres) in apple production, 
and is not high enough to tempt larger numbers 
into it. Of course if the apple growers do not 
receive almost as much for their work as the wheat 
raisers they may not consent, even in small 
numbers, to continue their occupation very long. 
But it is entirely possible that there will be a few 
who will like the work well enough to remain in 
it even if their return is very slightly less than it 
might be in the other line of production. There 
will be some, also, who, while earning, perhaps, 
less than most wheat raisers, remain apple growers 
because they are not well adapted for wheat 
raising and would make even smaller returns in it. 
Similarly some land will be devoted to apple 
growing, even with a low price of apples and with 
consequent small returns to the owner of the land 
so used, because the land will produce even 
smaller returns if used for the production of 



14 Earned and Unearned Incomes. 

wheat. Furthermore, if there has been produced 
in the community in question a certain more or 
less necessary quantity of wheat, additional amounts 
of wheat will have so little utility that apples or 
other goods will be preferred. The conditions of 
demand and value will, therefore, encourage a 
larger production of wheat than of apples but 
not a production entirely devoted to wheat. 

Thus, in a considerable community, demand and 
the conditions of production determine the relative 
amounts of different goods which are produced. 
Variety of consumption results both from the fact 
that increasing amounts of any good reduce its 
marginal utility so that additional amounts are less 
desired than other things, and also from the fact 
that additional amounts of any kind of goods may 
cost more by requiring producers and land which, 
except for the offering of a high price, would be 
devoted to another line of production."^ And as 
with an isolated individual, a community labors, 
through the activities of its members, to produce 
goods up to the point where the sacrifice of 
production is just balanced by the satisfaction or 
utility or the anticipated satisfaction of consump- 
tion. 

But in an organized community of the modern 
industrial type, carrying on economic activities 
with a considerable degree of specialization or 

^ The United States government has recognized this principle, 
during the present war, by guaranteeing to farmers a minimum 
price of wheat. An alternative might be government direction of 
occupations and investment by way of compulsion. A man might be 
compelled to work in some line of activity for a less return than 
he could get if allowed to work in some other line. 



The Determination of Value 15 

division of labor, the utility of any goods consumed, 
to the consiimer, is not necessarily or even probably 
just equal to the disutility of producing them, to 
the producer. For in such a community each person 
engaged in productive activity produces goods or 
services which others enjoy. ^ The labor sacrifice of 
the producers of hats may or may not — probably 
will not — be the exact equivalent of the enjoyment 
or anticipated enjoyment of the wearers of the 
hats. Thus, the hats in question may be of the 
variety affected by the well-to-do for formal 
evening wear, and may be, therefore, far removed 
from the list of necessities. The utility of or the 
satisfaction yielded by these hats may be compar- 
atively slight, but they are purchased because, to 
their purchasers, the utility of money is also 
comparatively slight. Yet the disutility of the 
last hour's work in making them, to the producers 
of the hats, may be considerable, far more than 
would be compensated by the enjoyment of such a 
luxury. These producers may be, for the most 
part, comparatively poor, so that the payment for 
the last hour of their labor represents necessities 
rather than luxuries. The necessities so purchased 
by them, although worth no more in the market 
than the hats which they have produced, have to 
these hat makers a utility corresponding to the 
labor sacrifice which they have to undergo in 
earning the necessities. Their necessities have, 
that is, a utility to them equal to the disutility of 
producing the hats. But the hats have not, to 
them, any such utility. 

8 Cf. J. B. Clark, Distribution of Wealth, New York (Macrnil- 
lan), 1899, p. 390. 



16 Earned and Unearned Incomes 

On the other hand, the wearers of the hats may 
be engaged in producing (or capital which their 
earlier efforts and saving have enabled them to 
accumulate may be instrumental in producing) 
the very articles of necessity which the hat 
producers consume. The utility of these articles, 
or services, to those who consume them may there- 
fore be much greater than the disutility (of labor 
or waiting^ or both) required for their production 
by the classes engaged in producing them.^° In 
modern industrial society, then, there is a rough 
correspondence between the utility of the goods 
which a man buys with the proceeds of his last 
hour of work, and the disutility of the work. But 
we cannot; in such a society with its division of 
labor, its strata of wealthy and poorer classes, 
and its differences of individual energy and taste, 
assert any very marked correspondence between 
the utility of goods to a consumer and the disutility 
of labor or labor and waiting undergone by a 
producer. 

§ 4 

Demand and Supply in Relation to Price 

The division of labor characteristic of modern 
society means that different persons produce 
different things for a market, that we specialize in 

^ See Chapter III, §5, for a brief discussion of whether waiting 
involves a disutility in the sense of pain-cost. 

10 We are here assuming that all the classes under discussion and 
enjoying incomes, contribute something to production. Neverthe- 
less, there are classes, as we shall later see, which reap where they 
have not sown. 



The Determination of Value. 17 

production and then trade to get what as in- 
dividuals or family groups we want. The problem 
of value in such a society is the problem of 
explaining what factors determine the ratios of 
exchange between different kinds of goods. The 
explanation of the problem begins with a study of 
demand and supply. The price of any article is 
determined, by the competitive forces of business, 
at that point which equalizes demand and supply. 
As has been frequently pointed out, demand must 
be distinguished from mere desire and supply 
must be distinguished from stock. There may be 
many persons who desire automobiles, but whose 
desires are of no significance economically because 
not backed by any financial ability to purchase. 
Demand implies ability to buy as well as desire 
to buy. Furthermore, since the amount which 
would be purchased by buyers depends partly on 
price, demand should be stated in relation to some 
price. We should therefore say, in defining de- 
mand: the demand for any kind of goods, e. g. 
cotton cloth, at any given price (per yard) is the 
amount (number of yards) of those goods which 
purchasers would take at that price. 

It is a generally recognized fact that demand is 
greater, other things equal, when price is lower, 
and that demand is less when price is higher.^^ 
Assuming other things equal, we can suppose a 
complete schedule of demands, corresponding to all 
possible prices. All but one of these demands are 

11 The case of goods purchased for display is probably not an ex- 
ception since, first, a reduction of price simply means that the same 
display requires a larger purchase and, second, a reduction of price 
may make possible some display by a lower economic group. 



18 Earned and Unearned Incomes. 

hypothetical, since they correspond to prices that 
do not exist. They are, in each case, what the 
demand would be if the price of the goods were 
thus and so. The demand corresponding to the 
actual price, represents an actual demand. But 
the other demands, especially those corresponding 
to prices near the actual price, are important, 
because they stand for forces of competition 
which help to determine actual price. // the price 
should go lower, demand would increase and might 
exceed supply, thus bringing price back again to 
the point of equilibrium. We must, therefore, 
recognize a series of potential demands corre- 
sponding to a series of hypothetical prices; yet we 
must, also, recognize that the actual demand for 
any article is the one which goes with the actual 
price or prices of that article during the period in 
question. 

Supply, also, needs to be carefully defined. The 
total stock, say of cotton, in existence at any time, 
is not the supply in the sense here used. Supply, 
like demand, should be spoken of in connection 
with price. The supply of any kind of goods, at 
any given price, is the amount which sellers would 
dispose of at that price. At a higher price, more 
persons would be encouraged to produce the goods 
for sale, and those already producing them would 
be inclined to produce more. At a lower price 
there would be less encouragement to the production 
of the goods. Even if we are dealing only with 
temporary or short-run supply, e. g. the supply of 
corn in April, so that a rise of prices could not 
for several months increase the amount produced, 
it might still be true that a higher price would 



The Determination of Value. 19 

tend towards a greater supply and vice versa. 
For at a price much below normal, many who 
otherwise might sell their corn, would be inclined 
to hold it in the hope of a higher future price. 
As in the case of demand, we may have a supply 
schedule with a supply corresponding to each 
assumed price; and each such supply is hypothet- 
ical except the supply which corresponds to the 
actual price. But the hypothetical supplies are 
not to be ignored since consideration of them 
enables us better to understand the nature of the 
competitive conditions by which price is fixed. 

Both demand and supply operate only during a 
period of time. This period of time may be longer 
or shorter according as the problem which in- 
terests us is long-run or short-run price. If we 
are considering the determination of so-called 
market price, our concern is with demand and 
supply during a brief period, e. g. a week, a day, 
or an hour. If we are considering the determina- 
tion of seasonal price, say of corn or cotton, our 
concern is with demand and supply between one 
harvest and the next. If we are considering, for a 
certain manufactured good, the determination of 
the price corresponding in some degree to the 
seasonal price of an agricultural product, our 
concern is with demand and supply of this good 
during a period so short that additional plants for 
the manufacture of the good could not be con- 
structed and so short that existing factories and 
machinery would not wear out.^- During such a 

12 Cf. Taussig, Pinciples of Economics, second edition, New York 
(Macmillan), 1915, Vol. i, pp. 149, 150. 



20 Earned and Unearned Incomes. 

period the good in question might be continuously 
produced, but the amount produced could not 
much exceed, though it might fall short of, the 
normal capacity of the plants. Finally, if we are 
considering long-run or normal price, our concern 
is with demand and supply over a longer period 
involving a number of seasons or, in the case of a 
manufactured good produced with large plant, 
involving a sufficient number of years so that the 
cost of construction of plants becomes an im- 
portant influence on the supply of the articles 
produced by such plants. 

It has been said above that the higher the price 
of a good, the larger (other things equal) will be 
the amount supplied, and the less will be the 
amount demanded. A high price, therefore, seems 
to be associated with a large supply and a low 
price with a large demand. This may appear to 
be contrary to the commonly accepted notion that 
high price means shortage of supply, or unusually 
large demand, or both. Yet in truth there is no 
inconsistency in the statement of these apparently 
opposite relationships. The phenomena in question 
involve an interaction of cause and effect. The 
prospect of being able to receive a high price for 
goods certainly stimulates the production of those 
goods. Yet a large production tends to force 
down the price. So, also, in the case of demand, it 
is certainly true that low prices of goods encourage 
purchases, and it is likewise true that large pur- 
chases tend to make prices high. 

Our present task is to examine the exact way in 
which the forces on the demand and on the supply 
side of the market operate to determine price. The 



The Determination of Value. 21 

price of any kind of goods tends always to be 
fixed at that point where demand and supply are 
equal. To demonstrate this tendency, let us assume 
prices at which demand and supply are not equal 
and show that such prices involve unstable equilib- 
rium and hence can not continue. We may sup- 
pose that, in a given market, a price of 8 cents 
a pound for cotton would equalize demand and 
supply and that, at such a price, both the demand 
and the supply would be 10,000,000 pounds. At 
7 cents, the demand would be greater, say for 
11,000,000 pounds, while the supply would be less, 
perhaps 9,000,000 pounds. Why, nevertheless, 
might not 7 cents be the resulting price? The 
answer is to be found, not in a mere statement 
that demand then would exceed supply, but in an 
analysis of the conditions and forces of the market, 
for which the terms demand and supply are merely 
our mode of expression. Since, at a price of 7 
cents, there are prospective buyers whose total 
purchases would aggregate 11,000,000 pounds, 
while, at that price, only 9,000,000 pounds would 
be forthcoming, not all of the prospective buyers 
willing to purchase at 7 cents, could get the de- 
sired amounts of cotton. Many of them would bid 
more than 7 cents rather than not get the cotton 
wanted and this bidding would force the price up. 
Any price lower than 8 cents would leave a pre- 
ponderance of force on the demand side of the 
market, and would involve a further competitive 
bidding up of price. But we could not expect to have 
a bidding up of the price beyond 8 cents. For at 8 
cents the supply is equal to the demand. In other 
words, all those who are willing to pay 8 cents a 



22 Earned and Unearned Incomes. 

pound can get all the cotton which, at that price, 
they are willing to buy. No one of them has 
occasion to offer a higher price to insure his 
getting the desired amount of cotton. If any one 
of them, for any reason, chooses to offer and pay 
a higher price, other purchasers need not do so. 
For, by hypothesis, the supply at 8 cents a pound 
is enough to satisfy the demand. Hence, even 
after the purchases of any who for any reason pay 
more are completed, there will still be enough 
purchasable at 8 cents to satisfy the remainder of 
the demand. We see, then, that the conditions and 
forces of a market will not permit the continuance 
of a price below that which equalizes demand and 
supply, but that there is no reason why intending 
purchasers should pay more than this equalizing 
price. 

Let us now suppose a price above that which 
equalizes demand and supply, in order to see 
clearly that such a price, also, could not continue. 
At a price of (say) 9 cents a pound, the demand 
for cotton might aggregate not over 8,000,000 
pounds; while the supply would be more than at a 
price of 8 cents and might aggregate 11,000,000 
pounds. Obviously, the 11,000,000 pounds which 
sellers might be willing to supply at a price of 9 
cents a pound, could not be entirely disposed of at 
a price of 9 cents. Unless the price falls, some 
who are willing to sell for less than 9 cents rather 
than not sell, will be left with cotton on their 
hands. These will bid against each other in order 
to dispose of their cotton, and this bidding will 
lower the price to 8 cents. But it will not lower 
the price more than that, for all those who are 



The Determination of Value. 23 

willing to sell at 8 cents a pound can find pur- 
chasers. Should any sellers choose, for some un- 
accountable reason, to dispose of their cotton at 
a lower price, nevertheless others would not have 
to do likewise; for the cotton supplied by these 
others at 8 cents a pound would be necessary to 
satisfy the demand and would, therefore, at this 
price, be purchased. We conclude that price is 
fixed, by market conditions, at a point such as to 
equalize demand and supply, since for price to be 
fixed at any other point involves a condition of 
unstable equilibrium. 

§ 5 

Explanations and Qualifications 

It is frequently stated that, assuming perfect 
competition, there can be but one price for a 
given kind of goods, in any market and at any one 
time. Thus, some men would not be selling cotton 
in a market at 7 cents a pound at the same time 
that others were selling for 8 cents. For, if the 
dealers asking 7 cents could completely satisfy 
the demand, those asking 8 cents would make no 
sales; while if those selling at 7 cents could not 
completely satisfy the demand, they would soon 
realize that a higher price could be asked. By a 
similar line of reasoning we may conclude that, 
if some purchasers were paying 8 cents and others 
only 7 cents, those having cotton to sell would 
sell it by preference to the former. If the pur- 
chasers at 8 cents could take the entire supply, 
those willing to pay but 7 cents would get no 
cotton, while, if the purchasers at 8 cents could not 



24 Earned and Unearned Incomes. 

take the entire supply, they would soon realize that 
they could get what cotton they wanted without 
offering so high a price. 

When it is said, then, that perfect competition 
makes impossible more than one price for any 
kind of goods in a given market at any given time, 
perfect competition must be understood to mean 
complete knowledge on the part of all the buyers 
and sellers, of conditions throughout the market, 
a readiness on the part of each buyer to buy where 
he can buy most cheaply, and a corresponding en- 
deavor on the part of each seller to sell to whoever 
will pay the most. So far as knowledge is in- 
complete, or so far as buyers and sellers are 
actuated by motives not purely economic (e. g. by 
the motive of friendship), there is the possibility 
of two or more prices existing side by side in the 
same market. On the exchanges, where goods are 
bought and sold in such large quantities as to 
make the effort for complete information clearly 
worth while, there is seldom any great difference 
in price among different transactions in any one 
kind of goods, taking place at the same time. In 
retail trade, where the purchases of any individual 
from day to day are so small that it sometimes 
seems scarcely worth the trouble to investigate 
slight differences in price or to go much farther 
than the nearest store, differences in price are 
more likely to arise or to persist. 

Besides the possibility — and, in some cases, 
probability — of differences in the price of a kind of 
goods at any given time, there is also to be con- 
sidered the likelihood — almost the certainty — that 
price will fluctuate from month to month, from 



The Determination of Value. 25 

week to week, from day to day, even from moment 
to moment. But some length of time is required 
for the carrying out of any transactions whatever. 
Demand and supply, therefore, almost necessarily 
have reference to a period of time rather than to 
an instant.^^ It follows that, except as we imagine 
a period of time infinitesimally brief, we cannot 
say with complete accuracy that demand and sup- 
ply are equalized by any one price. Demand for 
and supply of wheat, during a year, are equalized 
by a series of changing prices from day to day 
during the year, or by an average price. Either 
the seasonal price, or the long run or normal price 
is, then, an average of prices, an average of a se- 
ries of prices differing somewhat from each other. 
Even the market price has reference rather to a 
very short period than to a point of time. 

It is often said, in explanation of a rise in the 
price of some commodity, that the demand for it 
has increased or that the supply has decreased; 
and in explanation of a fall in price it is commonly 
stated that the demand has decreased or the supply 
increased. Obviously, an increased demand, say 
for cotton, which raises its price, is different from 
an increased demand which merely results from a 
fall of price. When we say that an increase of de- 
mand has raised the price of cotton, we mean that 
the potential demand at each possible price is 

13 Though we might define them as the amounts which, at any 
given instant, persons stand ready to buy and sell during some 
period. This would not help us any and would, indeed, be subject 
to the objection that what buyers and sellers, at any given moment, 
think they will do if prices remain unchanged, may not be at all 
what, even if prices so remained, they actually would do. 



26 Earned and Unearned Incomes. 

greater than previously at the same price. In 
other words, the whole demand schedule has shift- 
ed.^* Population may have increased or new uses 
may have been discovered for cotton or tastes and 
styles may have changed, so that cotton goods are 
more desired than formerly. Unless, therefore, 
price is higher, demand will exceed supply, buyers 
will bid against each other, and price will have to 
rise. 

Likewise, if it is said that the price of cotton 
rises because of a decreased supply, this must be 
held to mean, not that there is a decreased supply 
consequent on a lower price, but that there is, at 
each assumed price, a less potential supply than 
formerly would have been forthcoming at that 
price. This fact might be the result of soil ex- 
haustion or of a possibility of using land more 
profitably for some other crop or (as for a single 
season) of destruction of part of the crop by the 
boll weevil. In any of these cases demand, at the 
former price, would exceed supply, and, therefore, 
a higher price must result. 

Consider now the conditions which make for a 
fall in price. The increase of supply which may 
cause such a fall is not the increase which results 
from a larger demand and a higher price, but is 
an increase of supply due to other conditions than 
a rise of price. It may be due to improved meth- 
ods of cultivation or (as for a single season) to 
exceptionally favorable weather conditions. Un- 
less the price falls, there will then be an excess of 



1* See Fisher, Elementary Principles of Economics, New York 
(Macmillan), 1912, pp. 268-273. 



The Determination of Value. 27 

supply over demand. Sellers of the cotton there- 
fore bid against each other in price reduction, caus- 
ing the price to be fixed at a point such that the 
demand will be equal to the now larger supply. 

But price may be lowered, also, through a de- 
creased demand. This decreased demand must be 
supposed to be a demand smaller at each price 
and not a smaller demand consequent merely 
on a higher price. It may result from change 
of taste or style or from inability of part of the 
buyers, owing to changed conditions diminishing 
their prosperity, to make their desires effective 
in demand. In any such case only a lower price 
can equalize demand and supply. 

The case of monopoly price is not altogether ex- 
ceptional. Monopoly price, also, is fixed where 
demand and supply are equal. But the monopolist 
controls the supply of his product and can there- 
fore ordinarily fix his price so as to secure a larger 
net profit than would be possible if competition had 
to be met. But if, in any industry, monopoly seems 
inevitable or socially preferable, government may 
regulate the price or prices in question. Such 
regulation, if effective, will remove the motive to 
limitation of supply. The regulated monopoly will 
rather prefer to extend its business, as the only 
way of making a considerable profit. To regulate 
any price to a lower point than gives a normal 
competitive return to the factors engaged in the 
production of the good will cause these factors to 
be shifted, in part, to other lines of production. ^^ 

^5 Of course this does not mean that when the government, under 
its war power, limits a grocer's charge for sugar, the grocer will 
change his business. Even if the limitation were known to be for 



28 Earned and Unearned Incomes. 

If such a law is not evaded, it can only be because 
its penalties or other causes bring about an ap- 
preciable curtailment of demand for the good the 
price of which is regulated. But to regulate 
monopoly price down to a level of competitive 
profits, will tend rather to increase supply than to 
decrease it. 

§ 6 

Speculation in Relation to Price 

It has been above pointed out^^ that the price of 
any kind of goods may fluctuate from week to week 
or from month to month. This fluctuation is, how- 
ever, limited in extent by the activities of specula- 
tors, at least when speculation is intelligently 
carrried on. We might be inclined to expect that 
the price of (say) wheat would be very low im- 
mediately after harvest, because of the large quan- 
tity suddenly thrown on the market, that this 
lowness of price would discourage its production, 
and that its scarcity, realized particularly when 

a long period, he might yet remain in the business because expecting 
a substantial profit from his sales of other groceries. Nor is there 
any intention to deny that, by means of regulation, priorities, appeals 
and otherwise, government may decrease the consumption of and 
the demand for many goods by civilians in w^ar time, thus in effect 
compelling them to lend it their funds for its purposes, for lack of 
the customary alternative. But if government expends these funds 
there is not likely to be a reduction in average prices. (See §7 of 
this Chapter). Permanently to regulate everyone's consumption of 
goods of every kind (assuming such regulation to be possible) would 
amount to doing away with the competitive money system, for few 
would bother to acquire funds which they might not expend. 
i^In the immediately preceding section (§5) of this Chapter. 



The Determination of Value. 29 

each season's stock was nearly gone, would cause 
its price then to be very high. But speculators 
see chances to make profit from such differences 
of price. They, therefore, buy up the wheat in 
the fall, when its price is low, and hold it for sale 
at a time when a greater relative need makes its 
price higher. The large purchases in the fall tend 
to keep the price of wheat from going as low as 
it otherwise might, and the holding of a con- 
siderable stock into the spring for sale then, tends 
to prevent so great a rise as might otherwise occur. 
Speculative holding, in other words, increases the 
demand when price is low and increases the supply 
when price is high. The difference between the 
low and high prices will therefore, perhaps, on 
the average, about pay for the skill, trouble and 
capital furnished by the speculator. It is doubtless 
true that, in the absence of a speculating class, 
many farmers would themselves be inclined to hold 
their wheat till the season of highest price, but 
many others find this inconvenient and risky. The 
existence of a class of speculative buyers enables 
the farmers to sell at once for somewhere near the 
later and (on the average) higher price, and to 
avoid risk of loss. It is likely, therefore, to en- 
courage wheat production and thus to tend towards 
a reasonably low average price to the public. 
Purchase in the fall and holding by millers might, 
of course, serve in considerable degree the same 
purpose. But this would compel millers to be 
speculators and to invest large capital in the 
storage of wheat, and it is not certain that they 
would perform these services as cheaply as special- 
ists. 



30 Earned and Unearned Incomes. 

Consider now another type of speculation. The 
speculator who "sells short'' really promises to sell 
at a fixed future date and at an agreed price, goods 
which he does not possess at the time of making 
the promise. The buyer, of course, undertakes, on 
his part, to purchase the goods in question on the 
agreed date and at the agreed price. He is said to 
buy a "future." The buyer may be a manufacturer 
or a dealer to whom it is important that he shall 
know in advance just what certain supplies will 
cost when he is ready for them. He wishes to 
avoid any risk of fluctuation in the prices of these 
supplies. The speculator assumes this risk for 
him. Thus, a speculator may agree, in April, to 
sell wheat in June at $1.90 a bushel. The specu- 
lator should be an expert in predicting, so that to 
him the risk from possible fluctuations is less than 
it would be to others.^^ But even to the specialist 
there is some element of risk. The market price 
when June arrives may be $1.95. In that case the 
speculator is obliged to buy for $1.95 a bushel the 
wheat which he has agreed to sell for $1.90,^^ and 
loses $0.05 on each bushel. If the price turns out 
to be $1.87, however, he gains $0.03 on each 
bushel delivered. The fact that there are experts 

^'^ As Fisher has well pointed out, risk is fundamentally a matter 
of ignorance. Events occur only when their causes occur; and if 
we could know all the relations of cause and effect even in their 
most intricate ramifications and make ourselves familiar with ex- 
isting conditions, we could predict all events with certainty. Our 
uncertainty is due to no inconsistency of Nature but to an ignorance 
of Nature that makes consistency sometimes appear to us like Incon- 
sistency. See Fisher, The Nature of Capital and Income, New 
York (Macmillan), 1906, pp. 265-269. 

18 Or pay 5c a bushel to the man with whom he made the contract. 



The Determination of Value. 31 

who will promise, in advance, to sell at an agreed 
price, probably has some tendency to equalize 
prices. For if scarcity is feared, each intending 
purchaser (e.g. miller) would be likely to buy in 
advance and hold for his own future use a stock 
much larger than would satisfy his immediate 
needs. Such panic buying might make supply 
seem relatively short (say of wheat in the spring) 
and cause prices to rise unduly. But instead of 
thus purchasing in advance a large stock of the 
goods they desire, prospective users can arrange 
with speculators to be supplied with the desired 
goods as these goods are needed. 

It is, of course, the intelligent speculation of 
experts which thus tends over a period of con- 
siderable length to equalize prices. So far as the 
untrained public are lured into speculative use of 
funds by the prospect of large chance gains, the 
effect of their speculation is quite as likely to be 
greater price fluctuations as less. For the untrain- 
ed public are not unlikely to buy when prices are 
high, and to sell in a panic when prices are low 
thus causing them to go still lower. In short 
selling, also, they are as likely as not to make cor- 
responding errors of judgment. 

§ 7 

The Determination of the General Level of Prices 

Let us now apply the principles of demand and 
supply to the general level of prices. We shall 
see that much the same kinds of competitive forces 
which fix any one price (as above explained) in 
relation to other prices, fix the general level of 



32 Earned and Unearned Incomes 

prices of goods in terms of money. We shall 
consider the supply of goods, including the services 
of labor and of "waiting" (i. e. investing, or 
putting capital into use, the service for which 
interest is paid) offered for money, and the demand 
for goods by those having money to spend. 

Where there is only fiat (inconvertible paper) 
money, the supply of goods in general, offered 
for money, at any level of average prices of those 
goods, would be just the same as at any other 
level of prices. This is very nearly true no 
matter what the money system.^^ If wheat prices 
are higher than corn prices, or vice versa, 
productive effort may be diverted from one line 
into another. But we are now not discussing 
changes in individual or relative prices. We are 
discussing only changes in the general level of 
prices, the average of prices. If the general level 
of prices should double, there is no reason to 
believe that the amount of goods produced for 
sale would on that account greatly increase. 
Supposing a community to be in reasonable 
prosperity and business activity at the lower prices, 
an increase of these prices would not make possible 
a very greatly increased production. It would 
not enable men to work longer hours nor would it 
make machinery more efficient. Neither would it 
stimulate the sales of goods by making such sales 
more profitable, since a general rise of prices 
simply means that money has a less value. If 
everything should sell for twice as much money 
as before, the sellers would gain nothing, for the 

19 See remainder of this section for explanation of why it is not 
always entirely true. 



The Determination of Value 33 

things they desire to buy would also cost twice as 
much. Looking at the matter from any reasonable 
point of view, it must be admitted that the supply 
of goods in general, at a higher level of prices, 
would be no greater (or but slightly greater) ^^^ 
than at a lower level. Likewise, at a lower level of 
prices, the supply of goods would be no less than 
at a higher one. A lower level of prices would not 
mean less activity or a smaller sale of goods. It 
would pay as well to sell goods at a low level of 
prices as at a high level, since at the lower level 
the money received would have correspondingly 
greater purchasing power. 

The lower level of prices would only decrease 
the supply of other goods and the higher level 
increase it, in one contingency, and then only to a 
very limited degree. When the currency system is 
based on a precious metal, e. g. gold, a lower level 
of prices means a higher value of gold as money. 
It might therefore divert some labor from the 
production of other goods to the production of 
gold for coinage. A higher level of prices might 
tend, in the same degree, to divert labor from 
gold production towards the production of other 
goods. To this extent only, a higher level of 
prices would tend to increase the supply of goods 
in general other than money, and a lower level of 
prices to decrease it. 

On the other hand, a higher level of prices of 
goods would tend to decrease the demand for goods 
by persons having money to spend. For with 
higher prices, and no greater amount of money to 

20 See next paragraph. 



34 Earned and Unearned Incomes 

spend, buyers of goods would be unable to purchase 
as much as at lower prices. Lower prices of goods 
would mean that the money of purchasers would go 
farther. 

Let us now suppose a doubling of the amount of 
money. Prices would tend to increase in nearly 
the same proportion. Suppose prices did not rise. 
Then purchasers of goods would buy all they were 
in the habit of buying and still have as much 
money left to spend as they formerly spent all 
together. This they would endeavor to spend at 
once. For in modern countries money is not 
hoarded away, but only enough is kept on hand 
for emergency requirements, and the rest is spent. 
Those who save are spending just as effectually 
as any others. The difference is in what they 
buy. Those who save buy factories, warehouses, 
railroads, farms, etc. Even though their savings 
are put into a savings bank, they are none the 
less spent for investment goods. It follows that 
a sudden doubling of the amount of money, if 
prices did not increase, would mean a demand for 
goods far exceeding the supply. The amount of 
land is practically constant. Doubling che amount 
of money would not enable people to work longer 
hours and so increase the products of labor. In a 
busy community the supply of goods to be sold 
simply could not be doubled except with an in- 
crease of population or invention. The increased 
money would therefore mean that at the old 
prices the demand for goods in general would 
exceed the supply. Purchasers would bid against 
each other. Prices would rise. Equilibrium 
would only be reached, supply and demand be 



The Determination of Value. 35 

equal, at a general level of prices nearly (or, if 
fiat money, quite) twice that which had preceded.-^ 

21 The quantity theory of money has recently been attacked by 
Professor B, M- Anderson, Jr., in his book on The Value of Money 
(New York — Macmillan — ,1917. We may profitably digress, per- 
haps, long enough to consider the bearing of three of his hypothet- 
ical illustrative cases. In the first (pp. 150, 151), Professor Ander- 
son supposes a paper money convertible not in gold but in varying 
quantities of silver such that the amount of silver receivable for a 
unit of the paper is always the equivalent of a definite weight in 
gold. Under these circumstances, he asserts : "The causation as be- 
tween quantity of money and value of money would be exactly the 
reverse of that asserted by the quantity theory. A high value of 
money would mean lower prices. With lower prices, less money 
would be needed to carry on the business of the country. Paper 
would then be super-abundant. But in that case, paper would 
rapidly be sent in for redemption and the quantity of money would 
be reduced." But is it not true that the paper money will not be 
presented for redemption? On the contrary, the conditions assumed 
by Professor Anderson are precisely those which would prevent the 
sending in of the paper money for redemption. If prices are in- 
deed lower, those who possess this money have a more urgent 
motive than before to expend it while it will buy much, rather than 
to have it redeemed. The paper money will not be presented for 
redemption so long as it is worth more in goods than is the silver 
in which it is redeemable. And if and when it is presented for 
redemption, this will be the result of a diminished purchasing poiver 
consequent on its redundancy. In other words, we find here an in- 
fluence of the quantity of money on the prices of goods. 

In the second hypothetical case which we shall examine (pp. 296- 
299), Professor Anderson supposes an island the people of which are 
chiefly engaged in producing a single crop and to which comes by 
wire the news of a partial failure of the same crop in another part 
of the world. The island crop. Professor Anderson says, will rise 
in price and so will other goods in the island, which the prospec- 
tively prosperous planters now begin to buy. All this may be 
true but it furnishes no convincing refutation of the quantity theory 
of money, a theory which definitely asserts that both the quantity of 
money and the price level in a limited territory are largely deter- 
mined by prices outside of that territory. If, on the ialand, prices 



36 Earned and Unearned Incomes. 

In a country which has a gold standard monetary 
system prices are largely dependent upon the 
amount of gold mined and hence upon the number 
and richness of gold mines. 

If prices rose equally, this would mean a 
doubling in the money wages of labor for the same 
results produced and, similarly, a doubling in the 

rise before money floivs in, this can be true only to the extent that 
the now potentially more valuable crop is held for higher prices 
and hence trade is decreased, or by virtue of increased rapidity of 
money circulation or, most importantly perhaps, by the ability of the 
banks, in anticipation of crop sales at a higher price, to expand 
circulating credit {if reserves ivill permit) somewhat farther than 
usual. The quantity theory of money, properly interpreted, does 
not assume money to act on prices in any other way than through 
the market and through human motives and calculations. 

In the third case (pp. 309, 310), Professor Anderson argues that 
reduction of some prices, if quantity of money and volume of trade 
remain the same, may not raise other prices but may leave a lower 
average of prices than before. He supposes that maid-servants who 
were receiving $20 a month have their wages lowered to $10 by 
a combination of employers and, having no better alternatives, con- 
tinue to act as servants. He then proceeds to contend that although 
the employers have $10 more each to spend per month, the servants 
have each $10 less, that these changes just offset each other and 
that, therefore, prices will not change except for the fall of wages, 
the net effect being an average reduction. The $10, according to 
Professor Anderson, is simply "short-circuited." The fallacy lies 
in the assumption that this $10 is expended only once, e. g. by 
employer to retail shoe dealer, in the same period of time during 
which it would formerly have been expended twice, e. g. by em- 
ployer to servant and by servant to shoe dealer. Why not assume 
that, if the servant fails to connect with the $10, it goes from the 
employer to the retail shoe dealer and from the shoe dealer to the 
clothier? On the latter assumption, the fall of servants' wages, 
with volume of money and credit and volume of trade unchanged, 
certainly ivould mean a rise in some other price or prices. Pro- 
fessor Anderson has arbitrarily interpolated a decreased velocity of 
circulation of money- 



The Determination of Value 37 

money interest received for ''waiting." Aside 
from disturbing effects during the period of 
transition, the rate of interest would be the same 
with the high prices as with the low. The money- 
value of the sum waited for would be doubled and 
the money value of the interest would be doubled. 
The ratio between them would be the same as 
before. In other words, since prices have doubled, 
borrowers, for example, would require twice as 
many dollars as before and would also, of course, 
pay twice as many dollars in interest. 

In the light of the principles above set forth, 
regarding supply and demand, we can explain why 
the excessive amounts of inconvertible paper 
money sometimes issued by governments, issued 
particularly in time of war, have resulted in very 
exceptional rises in the price level. This in- 
creased amount of money means, at any level of 
prices, a greater demand for goods. Therefore, 
that the demand for goods may not exceed the 
supply, the level of prices must rise. There is 
another factor of importance at such times, viz., 
public confidence in the money issued. If there 
is a general belief that the money will become 
absolutely valueless or greatly decrease in value, 
then many who have goods to sell will refuse to 
sell them for this money, but will demand gold or 
silver or other goods in exchange. This decrease 
in the supply of goods, offered for money, will 
mean that only a higher level of prices than other- 
wise would result can equalize supply and demand. 
Thus is to be explained the high prices (and, 
reciprocally, the great depreciation of money) in 
such periods as the American Revolution, the 
Civil War, etc. 



38 Earned and Unearned Incomes. 

§ 8 

The Relation of Commercial Banking to the 
General Level of Prices 

Credit instruments, or credit rights — for the 
paper is in each case but evidence of the underlying 
obligation — act as substitutes for money primarily 
through the intermediation of commercial bank- 
ing,2- and foreign exchange banking. Commercial 
banks constitute an important part of the mechan- 
ism of trade. Their work facilitates internal trade 
and, in connection with the work of foreign 
exchange banks and brokers, facilitates external 
trade as well. It is estimated that nine-tenths of 
the total business in the United States is carried 
on through the use of bank credit.^^ 

Bank deposits (rights to draw from a bank or 
banks), which circulate by means of checks, may 
come into being in any one of several ways. One 
may become a depositor by directly depositing 
money (or the right to draw money, received by 
check from some one else, but this merely registers 
a transfer of a deposit and does not create one). 
One may become a depositor by borrowing from the 
bank in which the deposit is to be. If A goes to 
his bank and leaves there $50,000 cash, he there- 
upon is said to have deposited such an amount in 
the bank and can draw on this sum at will by 

22 Savings banks and investment banks perform, of course, im- 
portant functions, but do not have a part in providing a substitute 
for money. 

23 See Fisher, The Purchasing Poiver of Money, New York (Mac- 
millan), 1911, pp. 317, 318. 



The Determination of Value 39 

issuing checks against it in favor of any persons 
to whom he wishes to make payments. But A may 
also go to the same bank, give his endorsed note 
or other satisfactory security, and borrow $50,000. 
This money he leaves on deposit. The bank is 
then said to lend its credit. What A has borrowed 
is not money but the right to draw money by 
check, at will. The bank is under as much obliga- 
tion to redeem his checks on demand as if he had 
directly put money into the bank. On the other 
hand, A is under obligation to pay the bank, when 
his note matures, the amount borrowed plus 
interest. Finally, one may also become a depositor 
by endorsing to his bank a note or draft payable 
by a third party who then is the real borrower. 

It should be readily apparent that a bank can, in 
ordinary times, redeem all checks presented for 
redemption, without keeping for that purpose a 
cash reserve which at all nearly equals its liabilities. 
The total value of deposits which a bank is under 
obligation to pay out on demand, may be $500,000. 
Yet it is certain that all the depositors will not 
call for their money at the same time. Instead of 
drawing it out, most of them send checks back 
and forth to and from others who do likewise. A 
cash reserve of $100,000 may be ample. Putting 
the matter in the opposite way, we may assert that 
if there is $100,000 in cash in such a bank, the 
bank can lend its credit, i. e. more deposits or 
rights to draw, to the extent of (say) $400,000. 

We have said that different depositors in a bank 
liquidate their obligations to each other by giving 
checks. There^ is, then, simply a change on the 
bank's books. Any amount of obligations can be 



40 Earned and Unearned Incomes. 

thus balanced. Different persons are made success- 
ively creditors of the bank for larger or smaller 
sums. The situation is complicated, but the 
principle is not changed, when depositors of 
different banks have business dealings with each 
other. In this case, which is a decidedly usual one, 
the banks become successively each other's debtors 
and creditors and have to settle through a clearing 
house. Bank A may have accepted and paid cash 
for, or credited to depositors, many checks on 
Bank B. Bank B therefore owes Bank A. Similar- 
ly, Bank C may owe Bank B, etc. All of these 
complicated obligations are balanced by a clear- 
ing house, so that each bank pays what it owes net 
or receives what is owed to it net, and a great 
deal of flow of money is avoided. In other words, 
the principle of cancellation is applied whenever 
possible between banks, just as it is in any one 
bank to the depositors in it. 

The general level of prices is somewhat higher 
and the value of money is somewhat lower, because 
of the additional use of credit. The conditions of 
supply and demand require a somewhat higher 
level of prices, just as we have seen that they do 
when there is more money. Gold is cheaper. The 
demand for it is less. It does not need to be 
produced, and cannot profitably be produced, at 
such a low margin, i. e. from such unfavorable 
sources of supply, as would otherwise be worth 
while. But this bank credit is not altogether an 
addition to currency; it decreases the amount of 
gold money, and so is largely a substitution of a 
cheaper for a dearer currency. 



The Determination of Value 41 

But if bank credit can thus take the place of 
money, is there any limit to such substitution? 
Why might not credit expand and prices rise, or 
money be pushed out, indefinitely? The answer is 
that the amount of bank credit is pretty definitely 
related to the amount of money. In the first place, 
a certain amount of cash is needed in the banks, 
to maintain confidence. The amount so needed 
bears a relation to the amount of bank credit, and 
must be some reasonable per cent of such credit. 
Otherwise, the public is likely to become frightened 
and demand cash, and this cash cannot be paid. 
A margin against such contingencies is always 
essential and, for national banks of the United 
States and Federal reserve banks, as well as 
frequently for State banks, is required by law. 
So the total bank credit is related to the total bank 
reserves or cash in the banks.-* Banks main- 
tain the proper relation between deposits and 
reserves, by adjusting their rates of interest (or 
discount) charged to borrowers. If the deposits 
are in danger of becoming too great, relative to 
the reserves, a higher charge to borrowers will 
discourage borrowing, and so will limit the in- 
crease of those deposits which originate in the 
borrowing of deposit rights (or in the discounting 
of notes and acceptances) . 

The total bank credit is related, also, to the total 
cash in circulation.-^ Bank deposits passed by 
means of checks are absolutely unavailable for 

24 White, Money and Banking, third edition, Boston (Ginn), 1908, 
p- 197. The reserves required of national banks now have to be 
kept as deposits in the Federal reserve banks. 

25 Fisher, The Purchasing Poiver of Money, p. 50. 



42 Earned and Unearned Incomes. 

very many transactions. They are unavailable 
when the maker of a check is unknown, and they 
are unavailable, practically^ for small payments, 
such as street car fares. Even bank notes cannot 
fill up the entire circulation when, as is usually 
the case, the government allows them to be issued 
only in relatively large denominations. The 
smaller denominations are needed and government 
money is used. Business convenience, then, also 
compels a relationship between the quantity of 
bank credit and the quantity of government money. 
Since the quantity of bank credit is related in 
these two ways to the quantity of government 
coined and government issued money, changes in 
the latter tend to bring proportionate changes in 
the former. It is still true that prices depend upon 
the quantity of money, though the dependence is in 
part indirect. The demand for goods comes from 
those who have bank credit to offer as well as 
from those who have only money. 

§ 9 

Summary 

We began our study of value by assuming the 
simplest possible situation in which the principal 
value-determining forces might work, viz. a place 
inhabited by a single isolated man. Though in 
such a situation no exchanges are possible and, 
therefore, no value, in the sense of power in 
exchange, is possible, there may nevertheless be 
comparisons of utility. Such an isolated man may 
choose to produce one thing instead of another 
because its utility is greater to him than the 



The Determination of Value 43 

utility of the other, in relation to the time and 
intensity of labor necessary to produce it. It is 
likewise true for a person so situated, as for a 
person in a modern community, that a given unit of 
any good has less utility according as he possesses 
many units. If one kind of good has, because he 
possesses little of it, greater utility to him than 
another, and is yet no harder to produce, he will 
devote his attention to producing it instead of the 
other until the relative utilities are as the relative 
sacrifices or costs of its production. But this ad- 
justment may be reached either because the utility 
of the desired good becomes less as more of it is 
possessed, or because the labor of producing it 
becomes greater in proportion when more is 
wanted, or for both reasons. Some wants will 
eventually remain unsatisfied because they are not 
important enough to warrant the sacrifices of 
production, sacrifices which are likely to grow 
greater in proportion to the results obtained, as 
more hours per day are devoted to labor. 

In a modern community, the relatively large 
production of the most desired goods is brought 
about through the influence of desire upon demand 
and of demand upon the profitableness of supplying 
these goods. The principle of diminishing utility 
still applies and each purchaser buys goods desired 
by him only up to the point where the last unit 
purchased has a utility equal to the utility of the 
money which must be paid for it, which will be 
equal to the utility of the most desired alternative 
purchase that might have been made with the 
money. The goods which are generally so desired 
in quantity that the average purchaser buys much 



44 Earned and Unearned Incomes. 

before their utility becomes as low as the price, 
are goods which, therefore, it pays to produce in 
large amounts. Many persons and much land and 
capital are devoted to producing these goods. 
In a general way, we can state that producers carry 
on productive effort up to the point where its 
discomfort, weariness or disutility balances the 
satisfaction or utility which is the reward of that 
effort. But we cannot say that the disutility of 
productive effort, to the producer, equals the 
utility of the goods produced, to the consumer. 

A modern community is made up of specializing 
units; specialization requires exchange; and ex- 
change involves a rate or rates of exchange. In 
other words, exchange involves demand and supply. 
It is the forces of the market which fix the price 
of any good at the point where demand and 
supply are equal. At a lower price, demand 
would exceed supply and buyers would bid against 
each other, so raising the price. At a higher 
price, supply would exceed demand and sellers 
would bid against each other in order to dispose 
of the goods. Demand, supply and price have 
reference to a period of time which may be shorter 
or longer according as we are concerned with 
market, seasonal or normal price. 

Speculative buying and holding for a rise tends 
to keep up the prices of agricultural products when 
they first come upon the market and to prevent 
scarcity and high prices later. The selling of 
"futures" also tends towards equalization of prices. 
But speculation by persons inexpert in it may tend 
to increase price fluctuations instead of to diminish 
them. 



The Determination of Value 45 

The general average of prices or price level is 
also determined by demand and supply and largely 
resolves itself into a relation between the volume 
of purchasing power in the form of money and 
bank deposit (checking) accounts on the one hand 
and the volume of trade on the other hand. 



CHAPTER II 

Ultimate Determinants of Value 

§ 1 
Supply of One Good Means Demand for Other 

Goods 

If our explanation of the determination of value 
is to approximate completeness, we must not stop 
with an analysis of the nature of demand and 
supply, but must bring into view the forces which 
lie back of each. We shall begin with demand. It 
was said in the last chapter that desire is not 
demand. Nevertheless, desire is related to demand 
as (part) cause to effect. Demand depends upon 
desire for goods coupled with ability to pay for 
them. Other things equal, the greater the desire for 
any goods, the greater the demand for them. The 
desire of an isolated man for goods of any kind, 
expresses itself in his efforts to produce these 
goods. But where, as in a modern community, 
there is division of labor, each member of the 
community specializing in some one line, demand 
for any good on the part of producers of other 
things, expresses itself in their production of 
these other things for a market, in order that they 
may have the means to purchase what they desire. 
In effect, though the use of money intervenes, they 
buy the goods they desire with the goods they 
produce. If the farmer desires a piano, an 
automobile, good furniture and various other 
things, he works longer hours or more Intensively 
and produces more wheat, cotton, corn or beef. 

(46) 



Ultimate Determinants of Value 47 

Thus the goods of one kind, which he supplies, 
express and give effect to his demand for other 
goods. 

It is this fact which lay back of the contention of 
the classical economists, that there could be no 
such thing as a general oversupply, i. e. the supply 
of a larger amount of all kinds of goods than 
could be sold. There might be, through mis- 
calculation of producers, or other cause, an over- 
supply of one or a few kinds of goods compared 
to other goods. But this simply meant that the 
producers of the goods supplied in excess, say 
cotton, had plenty of those goods with which to 
purchase other goods. They had produced what, 
they believed, would be satisfactory means of 
payment for the goods desired. That is, they 
had intended to produce marketable goods. They 
had mistakenly produced too much of one thing 
(or a few things). But to assume that nothing 
they could have produced would have been accept- 
able to those with whom they traded, would be to 
assume that the latter had no wants remaining un- 
satisfied, for the satisfaction of which they were 
willing to pay. But if, in our system of division 
of labor, these latter, the purchasers of cotton, 
have produced any goods, it must be because they 
desire and, therefore, have a demand for, other 
goods, such as cotton. Though they do not desire 
(and, except at low prices, will not take) all of 
the cotton which has been too freely produced, 
they do desire other goods and have produced the 
wherewithal to pay for them. In other words, 
people produce goods in modern society chiefly as 
a means of getting other goods. Production of 



48 Earned and Unearned Incomes. 

goods by a person who intends to sell them es- 
tablishes a strong presumption that he wants 
something else, that his wants are not satisfied. 
What he wants to buy may be factories, railroad 
shares, office buildings and tenements, but it is 
pretty certain that he wants to buy something. If 
he puts his money into a savings bank, the situation 
remains the same, for he merely makes the bank 
his agent. The bank invests, i. e. buys, for account 
of its depositors. General overproduction would 
mean, then, a more or less universal production of 
goods for sale, by persons who did not want other 
goods in exchange for the goods sold. It would 
mean a desire to sell goods but no corresponding 
desire to buy goods. Since, in general, men sell 
only that they may buy, such a situation as a 
general phenomenon is almost unthinkable. It 
may seem to exist temporarily, and for special 
reasons, during a panic and business disorganiza- 
tion, but it is very far from being a normal condi- 
tion of economic life; nor can general oversupply, 
though seeming to exist during such a business 
breakdown because merchants and manufacturers 
are afraid to buy the usual amounts of goods, raw 
material and machinery, be put forth as a cause 
of the breakdown. In fact, the refusal of dealers 
and manufacturers to buy does cause it to appear 
that there is a surplus of goods, discourages 
manufacturers of those goods, throws men out of 
work, deprives these men of the means of 
purchasing, and so accentuates the appearance of 
superfluity. But the condition is one of industrial 
breakdown rather than of too efficient industrial 



Ultimate Determinants of Value 49 
functioning.^ Provided our economic machinery 

1 Professor Davenport says {Economics of Enterprise, New York — 
Macmillan — , 1913, p. 362) that in a time of depression "goods 
are offering against present money, while money is offering only 
against promises to pay in later goods or in later money with which 
presumably to command later goods. . . . The offers of present 
goods are not for present goods, and the offers of present money are 
not offers for present goods." In other words, everybody seems anx- 
ious to sell for money and relatively few seem anxious to spend 
money. 

To this one might reply that, although it seems to picture fairly 
well the situation during depression, yet the difficulty is that sellers 
of goods, despite apparent eagerness to sell, are nevertheless asking 
prices higher in money than buyers are willing to give, and that 
a revaluation of their goods by sellers, on a lower basis, would en- 
able them to be sold. Professor Davenport contends, to be sure 
(ibid, p. 303), that falling prices may not terminate the glut, since if 
the purchasing power of money over present goods is thus rising, 
"so also is rising its putative future purchasing power." But this 
can hardly be true without limit. At some degree of lowness of 
prices, purchasers of goods must realize that a better time to buy 
can hardly be expected to arrive. There must be a scale of prices 
at which, could it be generally accepted, goods would exchange 
freely, not reluctantly, for other goods through the medium of money. 
Indeed, Professor Davenport goes on to mention such considera- 
tions by way of accounting for the eventual revival from depres- 
sion. 

But be this as it may, assuming, for example, that all persons 
who have money are unwilling to spend it at any set of prices 
of goods, while all holders of goods are anxious to dispose of them 
for money on any terms, does it not still follow that all who have 
or produce goods for sale are demanders of other goods? In the 
assumed case, they are demanders of money; and this means, in 
effect, in a gold standard country, that they are demanders of gold. 
Temporarily, at least, the value of gold — or other primary-money 
commodity — is raised. Could such a condition continue, it would 
stimulate the production of gold and lead to the employment of 
more men to find and to work gold deposits. So far from there be- 
ing an all-round oversupply of goods, we could say with truth that 



50 Earned and Unearned Incomes. 

works smoothly, we need not fear a superfluity of 
goods, and when we appear to have such super- 
fluity, the real difficulty is to be sought elsewhere. 

§ 2 
Influences Back of Demand 

Intensity of demand for goods shows itself, as 
has been above stated, in intensity of effort devoted 
to producing other goods with which to buy them. 
But intensity of demand for any one kind (or a 
few kinds) of goods, may show itself also in a 
smaller consumption of other kinds, and in using 
most of one's available purchasing power to buy 
the goods most wanted. In other words, our 
estimates of relative utility inevitably involve not 
one but two comparisons or sets of comparisons. We 
must compare the utility of goods desired with the 
cost of the goods in terms of what we produce to 
pay for them and, therefore, in terms of the dis- 
utility (of effort and other sacrifice) involved in 
producing the latter goods. We must also compare 
the utility of any special goods desired, with the 

there was a relative undersupply of gold. Perhaps it is better, in 
view of the above complex of considerations, not to assert absolutely 
that all-round overproduction is impossible. During depression there 
is a condition which often seems like all-round oversupply, or prac- 
tically that. And it is of too temporary a nature, perhaps, to war- 
rant a shift of surplus labor to gold production even if that were 
in less degree than is the case on aleatory industry. Of course, also, 
where the currency is of the fiat order a temporary apparent re- 
lative undersupply of it, of the kind here in question, could not 
give opportunity for much employment of idle labor in producing it. 
But that the difficulty, in its origin, is always one of maladjustment 
rather than of too much production everywhere, should be clear. 



Ultimate Determinants of Value 51 

utility of other goods which might be purchased 
instead but which, because our earning power is 
not unlimited, may have to be sacrificed if the 
special goods most wanted are bought. 

To illustrate, a farmer's desire for a piano may 
cause him to work longer hours and cultivate his 
farm more intensively, in order to produce the 
extra amount of wheat necessary for purchasing 
the piano without greatly sacrificing his other 
needs. His sacrifice takes then the form of the 
extra effort required to earn the requisite money. 
On the other hand, his desire for the piano may, 
conceivably, cause him to work no harder but may 
induce him to give up owning an automobile. In 
that case, his sacrifice takes a different form, 
but may be regarded as none the less a sacrifice. 
The same principle applies to anything which one 
may purchase, — coal, shoes, sugar, etc. 

We have already seen^ that as a person has more 
and more units of any article, the utility or 
desirability of additional units declines. A pound 
of sugar, to a man who could never have but a 
single pound, would be highly prized. A second 
pound would be somewhat less desired but would 
yet have high utility. But to a man who regularly 
consumes 75 pounds of sugar a year, one pound 
more or less is of relative unimportance. In the 
case of some goods, utility would diminish rapidly 
as the amount owned increased. In the case of 
other goods, utility would diminish slowly. In any 
case, a person desiring the goods would purchase 
them up to the point where the last unit secured 

2 Chapter I, §i. 



52 Earned and Unearned Incomes. 

was just equal, in his mind, to the price paid. The 
purchaser of sugar would buy each year or each 
month such an amount that the last pound pur- 
chased would just about seem worth while getting 
at the price. The purchaser of coal would buy, 
each winter, such a number of tons that the last 
ton would just about seem worth the price paid. 
If the price were lower he might luxuriate in 
more heat. If it were much higher, he might 
endeavor to get along with one less heated room. 
The last ton purchased would just about seem 
to be the equivalent, in utility, of the money spent 
for it or (since money has utility only for what it 
can buy) of the other goods which could have 
been secured with the price of that ton but which 
are sacrificed in order to get the coal. This last 
ton, being just equal in utility to the money neces- 
sary for its purchase, would just compensate for 
the disutility (labor or other sacrifice) involved 
in earning that last addition to the year's income. 
This statement remains true in principle even 
when the assumed purchaser of goods finds labor 
a constant delight. For such labor still involves 
a sacrifice of sleep, or leisure or reflection, which 
may be no less or even more delightful to him. 
As to the person who gets all or nearly all his 
income from property, it can hardly be said that 
the last hour's work has any disutility at all. 
But, even so, goods may still be valued in terms 
of other goods foregone.^ The last ton of coal 
purchased is called the marginal purchase, its 
utility, marginal utility, the effort or other sacri- 

3 See Davenport, Economics of Enterprise, p. 93. 



Ultimate Determinants of Value 53 

fice necessary to earn that much more (e. g. the 
last and, therefore, hardest or most disagreeable 
hour's work, if work must be undergone) is the 
marginal effort or sacrifice, and its disutility is the 
marginal disutility. At the point where the coal 
purchasing stops, the marginal utility of coal is 
just equal to the marginal utility of money or of 
the goods other than coal for which the money 
might be spent and, if the money had to be earned, 
is just about equaP to the marginal disutility oi 
earning that money. 

We may nov/ restate the relation of demand to 
price, pointing out that demand rises as price 
falls and that this is true partly because a 
fall of price induces some to be purchasers who 
would not buy at a high price, and partly because 
those who would buy at a high price will buy more 
if price be lower. 

A further statement may be made, which has to 
do with both demand and supply. A great rise 
in the price of (say) wheat, would tend to de- 
crease the demand for wheat by persons producing 
other goods to get it, partly because it would induce 
some to give up producing the means of purchasing 
wheat and to produce, instead, the wheat itself. 
On the other hand, a great decrease in the price 
of wheat (resulting, perhaps, from the invention of 
better harvesting machinery and from improved 
methods of soil enrichment^, would tend to in- 

* Not necessarily exactly equal since the money may be earned at 
one time and spent at a later time, and since, therefore, its utility 
may be different from its estimated utility. 

5 These improvements, other things equal, mean that fewer are 
required to produce wheat, and, therefore, unless some change 



54 Earned and Unearned Incomes. 

crease the demand for it by causing some who had 
been producers of wheat, to produce other things 
and therewith buy wheat. Otherwise putting the 
matter, we may say that the amount which would 
be paid for wheat in terms of other goods, is 
roughly limited (if we have long periods and 
possible change of occupation, in view) to the 
amount of other goods which could be produced 
with the same (marginal) sacrifice as the wheat. 
A price of wheat so high that it is much more 
difficult to get the wheat desired, by producing 
other goods with which to buy it, than to produce 
the wheat itself, would mean a smaller demand 
for wheat,^ and demand and supply would only 
be equalized, in the long run, by a shifting of a 
part of the community's producing power into 

their occupation, prices will fall so far as to make wheat production 
relatively unprofitable. That is, prices will fall more than the im- 
provement in methods can permanently justify. 

6 Unless we think of wheat producers as being demanders of 
wheat, directly or indirectly, from themselves. Considered as a 
group, however, the producers of wheat and wheat products are 
suppliers of wheat to the rest of the community. The part of the 
product that they themselves consume, they cannot be said (as a 
group) to demand, in the sense of buying it with other goods. 
Hence, if other producers are pushed or drawn into wheat produc- 
tion, because of high wheat prices, the demand for wheat may be 
said to be smaller. In a more detailed, and, therefore, perhaps, 
less philosophical sense, producers of wheat may be said to demand 
wheat, indirectly, if they sell their wheat and buy wheat flour. Their 
demand for the flour from the millers is, indirectly, a demand for 
wheat since it occasions demand for wheat by the millers. In 
this sense, the wheat producers may, often, literally buy back 
their own wheat. It is possible, in short, to conceive of the wheat 
consumed by the wheat producers themselves as entering into 
neither demand nor supply, or to conceive of it as entering into 
both. 



Ultimate Determinants of Value. 55 

wheat production. There is a very real sense, 
then, in which the demand for an article, and the 
amount which consumers will pay for it, depends 
upon its cost of production. They will not, in the 
long run, pay more for it than the amount of 
other goods which the same sacrifice will produce. 
Normal or long run demand may therefore be 
said to depend on the (marginal) utility of the 
goods demanded, on the (marginal) utility of the 
other goods which will have to be sacrificed if 
these are enjoyed, on the (marginal) disutility or 
sacrifice of producing the goods necessary to pay 
for the desired goods, and, by way of comparison,^ 
on the disutility or sacrifice necessary to produce, 
instead of buying, the goods desired. 

Cost of production has often been spoken of as 
if it influenced only supply of goods and not 
demand. But this, if the position here taken can be 
justified, is not consistent with a broad philosoph- 
ical view of the phenomena in question. Conditions 
of cost influence demxand no less than supply,^ even 
though their influence on demand is not obvious 
without a philosophical analj^sis of economic 
relations. 

This point has importance in the distinction 
between goods which have and goods which have 
not any cost of production, i. e. between goods 
which are reproducible and goods which are almost 
or absolutel}^ fixed in quantity. Ordinary commodi- 

■^ A similar comparison, amounting to the same thing, would 
be one of the utility of the desired goods compared with the 
utility of other goods producible at the same sacrifice. 

s If economists dislike this contention, they must, it would seem, 
abandon the traditional definitions of demand and supply- 



56 Earned and Unearned Incomes. 

ties are in the first class. Land space is in the 
second class. The demand for ordinary commodities 
depends not only upon their utility, but in part, as 
we have seen, upon their cost of production, for 
the majority of people will not long pay for any 
good more than this cost, i. e. more than the amount 
of other goods which the same effort, etc., would 
produce.^ But the demand for land space depends 
(assuming any given prices) solely on its utility, 
for it has no cost of production. ^"^ At any set of 
prices for the different pieces of land in a 
community, the demand would be almost totally 
unaffected by any possibility of producing the 
desired land instead of buying it, for, on the whole, 
and with a few exceptions of made land, there is 
no such possibility.^^ Buyers of land would 
purchase it up to the point where its utility, for 
their purposes, equalled its price. At a low set 
of prices, more land would be bought than at higher 

^ The above statement Is made in general terms and must be 
taken by the critical reader with the qualifications already made in 
this and the previous chapter as to difference of cost to different 
producers, marginal cost, and dependence of this cost on amount 
produced. But the statement as here made is sufficiently accurate 
for the purpose in hand. 

10 Though improvements on it, of course, do have. But such 
improvements are to be sharply separated in thought from the land 
itself. 

11 It is not the intention to suggest that the buyer or renter of 
land space has no alternative- He may use a smaller piece of land 
more Intensively instead of a larger piece less intensively. Thus, 
he may put a twenty-story building on a small area instead of put- 
ting a ten-story building on a larger area. He may choose a poorer 
site instead of a better one. But the buyer or renter of capital has 
alternatives of these kinds and has in addition the alternative of 
becoming himself a producer of the sort of capital wanted. 



Ultimate Determinants of Value. 57 

prices. But if the land were sufficiently desired by 
purchasers, to make the prices high, their demand 
would not be likely to be limited by any alternative 
of shifting their industry and becoming producers 
of land. To an extent, land fertility can be produced 
by human effort but, practically speaking, land 
space cannot be. 

§ 3 
Influences Back of Supply 

Let us now analyze the supply side of the market 
in the same way. The supply of any good, e. g. 
cotton, depends, first, on the price that can be real- 
ized for it, per pound, i. e. ultimately on the amount 
of other desired goods obtainable in exchange for 
the cotton. A higher price would encourage larger 
production. Second, the supply of cotton depends 
upon the intensity of desire for these other goods 
securable in exchange by the producers of cotton. 
Supposing the intensity of desire for these goods 
on the part of cotton producers to be very great, 
they would produce large amounts of cotton with 
which to buy these other goods. Assuming their 
desire for other goods to be weak and easily satis- 
fied, they would care less to produce large amounts 
of cotton with which to buy these other goods. If 
the producers of cotton and of the other goods for 
which it is given are alike members of a single 
homogeneous population, able to change easily in 
large groups, from one occupation to another, the 
intense or weak demand of cotton producers for 
other goods will indicate an intense or weak de- 
mand in the whole community for goods in general, 



58 Earned and Unearned Incomes. 

probably including cotton, and may not imply any 
special effect on the value of cotton in relation to 
other goods. But if, as is the case, cotton is only 
producible in certain climates, and if those who 
live and work in those climates are persons whose 
wants are slight and easily satisfied, the effect on 
the supply of cotton may be important. In trade 
between highly civilized countries on the one hand 
and primitive peoples on the other, the lack of de- 
sire upon the part of the latter for anything beyond 
a few simple necessaries of life, tends (assuming 
their labor to be wholly voluntary) to restrict the 
supply of the goods they produce and so to raise 
the prices of such goods. This result will not fol- 
low, of course, if the goods in question can be 
cheaply produced in the civilized country. 

Third, the supply of cotton may depend upon the 
disutility of producing it, i. e. the unpleasantness 
or difRcultj^ of or disinclination to do the work or 
make the accumulations of capital used in pro- 
ducing the cotton. Thus, if exhaustion of the 
soil should increase the labor per pound of produc- 
ing cotton, this would discourage its production 
and, if only the same price as before could be se- 
cured, less and perhaps much less cotton would be 
produced than before. On the other hand, should 
improvements in machinery and in methods of 
soil culture make the labor cost per pound of cotton 
less than before, the production of cotton would 
be encouraged and, at the same price, a larger 
amount of cotton than before would be produced 
and sold. 

Summarizing our conclusions thus far and re- 
stating them, we may say that producers of cotton 



Ultimate Determinants of Value. 59 

will supply it up to the point where the (marginal) 
disutility to them of producing it is just balanced 
by the (marginal) utility to them of the goods 
which they get in exchange. 

But in presenting the above considerations, we 
have failed to emphasize an influence to which the 
greatest importance should be attributed. This is 
the influence exerted by comparison, in the minds 
of producers, of the various ways of getting what 
they want as consumers. Thus, the producers of 
cotton are producing it, in large part, as the most 
effective way, for them, of securing wheat, bacon, 
sugar, etc. Should the price of cotton greatly fall 
or of these other things greatly rise, so that the 
produce of a year's labor in cotton raising would 
purchase much less than before of these other 
things, some of the cotton producers (or persons 
who would have become such), might instead turn 
their efforts to other lines, to producing goods 
other than cotton, which they could more profit- 
ably exchange for the various goods they desired, 
or to producing, themselves, some of these desired 
goods instead of buying them with cotton. We 
may, indeed, regard the cost of production of 
cotton as being the amount of other goods, of one 
and another sort, which the same effort and self 
denial would produce and the production of which 
the cotton raisers forego when they raise cotton. 
Assuming the possibility of an easy shifting of 
occupations, they will not care to produce cotton 
if they have to dispose of it for much less than 
that amount of other goods which the same effort 
and sacrifice would produce. To say that they 
must take less than this, is to say that some other 



60 Earned and Unearned Incomes. 

line (or lines) of production is (or are) more 
profitable than cotton raising, and such a condition 
would tend to decrease the supply of cotton.^^ 

On the supply side then, as on the demand side 
of the market, in the case of any goods, the cost 
of production is an important consideration, cost 
of production being understood to mean the amount 
of other goods which the same effort and sacrifice 
would produce. Purchasers do not wish to pay 
more than this cost of production and will, in 
large part, change their occupations and cease to 
appear on the demand side of the market, if they 
do have to pay more. Sellers do not wish to take 
less than this cost of production and will, in 
large part, change their occupations, and cease to 
appear on the supply side of the market if they 
do have to take less. It need not surprise us that 
demand and supply are thus both so closely related 
to cost in the sense of the word here used. Let 
us remember that those who demand one kind or 
several kinds of goods, supply other goods, and 
that those who supply one kind of goods demand 
other kinds. The demander is a supplier and vice 
versa. Every person is at the same time a buyer 
of some things and a seller of other things. And 
every person, in a modern society based on indus- 
trial freedom, has the alternative of becoming a 
buyer of what he now sells and a seller of what 

12 Another way to put the same thought is to say that the supply 
of cotton would decrease if the producers of it have to expend 
more effort and sacrifice in producing cotton as a means of paying 
for other desired goods, than would be required to produce these 
goods direct or to produce something other than cotton with which 
to buy them. 



Ultimate Determinants of Value. 61 

he now buys. In fact, every industrial unit has 
many alternatives and all of them are determining 
conditions of his action as an economic unit in 
industrial society.^^ When buyers, taking them as 
a whole, refuse, in the long run, to pay for a good 
more than its cost of production, and when sellers, 
taking them as a whole, refuse, in the long run, 
to accept less, both groups are influenced, not only 
by their available alternatives of varying their 
consumption in amount or in proportions and 
of varying the intensity or degree of their pro- 
ductive efforts and other sacrifices, but also, and, 
for many economic problems, most importantly, 
by their alternative of shifting their fields of in- 
dustrial activity.^"* 

On the supply side, as on the demand side, it is 
worth while emphasing the distinction between 
goods producible in indefinite amounts, in relation 

13 Cf. Professor H. J. Davenport's discussion in his Economics of 
Enterprise, Chapter VI. 

1* There is here no intention to deny, of course, that an individual 
concern can afford to charge a lower price if it can fully utilize its 
plant than if it is unable to secure business enough to utilize its 
plant to anything like full capacity. Such a concern might, there- 
fore, be willing to sell a larger amount of goods for as low a 
price as that for which it would sell a smaller amount. Where 
the size of plant of maximum efficiency is large enough to supply the 
entire market for any article or service (e. g. electric light in a city), 
monopoly production is likely to be the cheapest. (For a fuller 
discussion of the conditions fixing the rates charged by a company 
whose facilities are not completely utilized, see the author's Principles 
of Commerce, New York — Macmillan — , 1916, Part III, Chapter I, 
§6 of Chapter II, and § i of Chapter III.) But it should be clear 
enough that where an increase of output is dependent upon the 
construction and maintenance of several plants, a higher price is 
more likely to increase supply than a lower price. 



62 Earned and Unearned Incomes. 

to the world's need of them, such as wheat, corn, 
cotton, iron ore; and goods more or less fixed in 
quantity, such as original Greek statuary, the 
paintings of Michael Angelo, and, chief in impor- 
tance, land. It is true that producers of wheat, 
corn and cotton will not engage in the production 
of these crops at a price below cost (in the sense 
and on the hypotheses herein set forth). But 
the sellers of land space do not have cost of pro- 
duction to consider, because land space practically 
speaking (though there is some ''made land") can 
not be produced. The owners of land space there- 
fore, in selling it, consider only the utility to them 
of what they can get for it compared to the utility 
to them of the land. The producer of cotton, also, 
after he has produced it, considers only the utility 
of what he can get for it compared to the 
utility to him of the cotton — if he has any way 
of using it all. But cotton is constantly being 
used up and requiring to be resupplied and 
before producing it, the cotton farmer most 
certainly will consider its cost of production, nor 
will he go on, year after year, raising cotton 
for less than this. 

§ 4 
Labor Costs in Production 

Having made the foregoing general analysis 
of cost of production and its influence on de- 
mand and supply, we have now to enter into 
some of the more detailed aspects of cost. A 
larger supply of any good (assuming no im- 
provements in methods of production) involves 



Ultimate Determinants of Value. 63 

either more labor by those ah-eady engaged in 
producing it or a larger number of such pro- 
ducers. Neither can ordinarily be had without 
higher price as an inducement. Let us first con- 
sider the possibilities as regards getting more 
goods of a given sort by engaging more per- 
sons for their production. In much of our pre- 
vious discussion, we have seemed to assume 
that the tendency, so far as change of employ- 
ment is easy, is for returns to workers to be 
about the same in one line of activity as in 
another, in proportion to effort and other sacri- 
fices. But we have not emphasized the fact 
that a given line of activity may seem much 
harder, much more distasteful, to some men 
than to other men. This fact may sometimes 
have an important influence on price. By way 
of illustration, let us suppose a change in 
occupations abroad of such a sort that far 
more American wheat was wanted than before, 
and this not temporarily owing to war condi- 
tions but more or less constantly. For a while 
this want might be very inadequately satisfied, 
but should the demand and the resultant high 
price continue, larger acreage in the United 
States would be sown to wheat, and a larger 
proportion of the American population would 
devote themselves to wheat production. Of 
those who changed from other lines into agri- 
culture, some would be persons with no train- 
ing for the work and others persons with com- 
paratively little taste for it. To make the large 
production continuous, the price of wheat must 
remain high enough to keep these persons in 



64 Earned and Unearned Incomes. 

the work. After a period of a generation or 
two, new tastes and habits would have time 
to form, and a larger number of men than 
before might be willing to engage permanently 
in agriculture without much extra inducement. 
But during a short period, though a period 
of some years, a considerable inducement to 
wheat production, in the form of high prices, 
might be necessary. 

There is, however, in addition, the possibil- 
ity of securing more goods of a given sort, 
e. g. wheat, by getting those already engaged 
in its production, to work more intensively or 
to work longer hours. But additional hours 
of labor become progressively more and more 
a burden and there is a progressive disinclina- 
tion to perform such labor. At first thought 
we might suppose that a higher rate of pay 
per hour would encourage working longer hours, 
that a higher price of wheat, for instance,, 
would cause persons already engaged in wheat 
production to work longer hours and thus pro- 
duce more wheat. But it is perhaps equally 
likely that the larger returns per hour, result- 
ing in greater prosperity, would make the long- 
er hours of labor seem less necessary as a 
means of getting a living^^ and would encourage 
the taking of more leisure. So there is no cer- 
tainty that a higher price would in that waj^ 
add to the supply even temporarily. So far as 
agriculturists could change from other lines to 

1^ Cf. Jevons, The Theory of Political Economy, fourth edition, 
London (Macmillan), 1911, pp. 179-183. 



Ultimate Determinants of Value. 65 

the production of wheat, a rise in wheat 
prices might induce them to do so, and event- 
ually it would bring more men into agriculture; 
but it very likely would not increase the in- 
tensity or the hours of labor and it might, 
conceivably, even decrease them. It does not 
follow that a lower price would cause more 
wheat to be produced than a higher. For 
though sm.aller returns from wheat and other 
farm products might necessitate somewhat more 
work to make a living, if agriculturists had no 
alternative, yet, as things are, lower returns 
than in other lines would divert many into 
these other lines and so almost of necessity 
decrease the supply of agricultural produce,^^ 
just as higher returns would draw more men 

1^ Even if a lower price, e. g. for wheat, would actually bring a 
larger supply than a higher price — as it might if wheat producers 
were unable to change their occupation and simply had to work 
harder for a living — price would still be determined at the point 
where demand and supply were equal and, probably, there would 
be only one such point. Any other price would mean a position of 
unstable equilibrium and could not continue. The high price, 
though it might, on the present hypothesis, limit supply, would be 
likely to limit demand still more. The low price, though it might 
increase the supply, would presumably still more increase the de- 
mand. Competition would therefore operate to fix price at the point 
of equality. We are not here dealing with a supply which, at 
any price, is a certain amount or indefinitely more (see Fisher, 
Elementary Principles of Economics, New York — Macmillan — , 1912, 
PP- 3i7> 324) but with a supply which, though it increases as price 
falls, increases, for each lower price, only up to a certain limit. 
Some point of equilibrium there must be, unless we suppose supply 
to increase as price falls, and to decrease as price rises, more rapidly 
than demand ; and that, therefore, demand exceeds supply at the 
higher prices, and falls short of it at the lower. 



66 Earned and Unearned Incomes. 

into wheat raising and increase the number of 
bushels produced. 

§ 5 

Land and Capital Costs in Production 

We have seen that to get a larger supply of 
any good may be expected, ordinarily, to require 
a larger amount of labo7\ Attention should 
now be called to the fact that it requires the 
use of more land or a more intensive application 
of labor and capital to land already used for 
the line of production in question, or both. 
Suppose, as before, that there is desired the 
production of wheat. Assuming other things 
to be equal, more wheat can not be produced 
unless the land already devoted to wheat pro- 
duction is cultivated more intensively, unless 
additional land not previously cultivated is 
brought under cultivation, or unless land pre- 
viously used for other purposes is diverted to 
the production of wheat. To get larger wheat 
production in any of these ways, requires a 
higher price. Assume that the price has been 
$1 a bushel. At that price the average producer 
will cultivate his land with whatever degree of 
intensiveness yields the greatest gain. He will 
increase the amount of labor devoted to cul- 
tivating his wheat land, as long as the wheat 
yielded pays the wages of this labor and a satis- 
factory return on the necessary capital. But 
the point is soon reached beyond which ad- 
ditional labor can not, without spreading over 
more land, produce wheat enough to cover 



Ultimate Determinants of Value. 67 

the requisite wages. For it is impossible, on 
a given piece of land, indefinitely to increase 
the amount of labor and get a proportionately 
increased product. This fact is, of course, general- 
ly known to farmers, and, in its applications to 
urban land, is known to merchants and manufac- 
turers also. But if wheat sells for $1.20 a bushel, 
and money wages remain the same, or even advance 
somewhat,^' it may be profitable to cultivate a 
given piece of land more intensively than other- 
wise would pay. An additional man may be hired 
and, though the amount of wheat produced 
probably will not increase in anything like the 
same per cent as the labor, the increase, at the 
new and higher price, will be more likely to 
cover the additional wages paid and to yield some 
profit, than it would at the lower price. But the 
point ta be emphasized is that, other things equal, 
it will not pay thus to cultivate the land more 
intensively unless the price to be received is 
higher. The higher price is a necessary means 
of bringing out the larger supply. 

The same principle applies to urban land. To 
increase the amount of manufacturing or of retail 
trading on a given area, necessitates more crowded 
quarters or else higher buildings, and the higher 
buildings are made the more solid must be their 
foundations. In other words, a point is eventually 

1'^ To the objection that we have assumed wages virtually to fall 
since we assume wheat prices to rise in a greater degree than 
wages, the answer may be made that, if the prices of other goods 
do not rise at all, wages need not rise as far as does wheat in 
order that wage earners should be able to enjoy a larger amount of 
goods-in-general than before- 



68 Earned and Unearned Incomes. 

reached where additional stories, and, therefore, 
additional production on the same land space, 
yields a less reward than would smaller production, 
proportionate to the labor (including the labor 
of building) expended. 

If all land had exactly the same capacities and 
advantages, an additional demand for wheat 
would not for any great length of time cause 
wheat land to be cultivated any more intensively 
tnan before, as compared with land used for 
other purposes. It would always be more profit- 
able, if a larger amount of wheat were wanted, to 
divert land from the production of other goods 
into the production of wheat. But in fact, land 
has not all the same capacities. Hence there 
would be some loss in turning into wheat produc- 
tion land previously used to produce (say) corn. 
The corn land is farther south, on an average; 
and rather than get all the extra wheat desired, by 
diverting former corn land into wheat production, 
it may be desirable to get part of it Dy cultivating 
more intensively the land already devoted to wheat 
raising. But it is also true that an additional 
demand for wheat (or other goods) is likely to be 
partly satisfied by diverting into such production 
land which was previously otherwise used. This, 
of course, necessitates a higher price for the 
wheat. Let us suppose that tastes or customs 
have changed so that wheat is even more used as 
food than now and com less so. Since some of 
the land used to produce corn can also be used 
to produce wheat, the probability is that part of 
the additional wheat wanted will be so secured. 
But it will not be so secured except at a higher 



Ultimate Determinants of Value. 69 

relative price for wheat. Presumably the lands 
used for producing corn are devoted to that 
purpose because, at existing values, it pays best 
so to devote them.^^ But with wheat higher in 
price, and corn, perhaps, lower, it may be worth 
while to divert some land from the one use to 
the other. The use which was before less profit- 
able, now becomes more profitable in relation to 
other uses. The two kinds of goods are compet- 
itive and that one which can pay more for the use 
of the land, gets it.^^ A change in relative values 
may give to a wheat crop, land which would other- 
wise have been devoted to corn; or may, in a 
city, give to a shirt factory, land which would 
otherwise be used for a shoe factory or for a 
wholesale grocery. 

Following our previously adopted sense of "cost 
of production," we may say that the cost of 
production of w*heat (at the margin of wheat 
production, viz, on the land which it is just worth 
while to devote to that purpose instead of to some 
other — or no other — purpose, and with the labor 
which is just induced to follow wheat production) 
is measured by the value of the other goods, e. g. 

1^ Though it will also pay, in many cases, to alternate or rotate 
crops, for the sake of retaining fertility, nevertheless, a higher price 
of wheat would introduce it into rotations from which, at a lower 
price, it would be omitted. 

19 This idea, suggested by Mill in a reference to what he regards 
as an exceptional case {Principles of Political Economy, Book III, 
Chapter IV, §6), appears to be clearly understood by Jevons who 
discusses it at length in the preface to the second edition of his 
Theory of Political Economy, (See pp. xlvii-li of the fourth edi- 
tion. ) 



70 Earned and Unearned Incomes. 

corn, which the same labor and land might have 
produced instead. 

Since, besides land and labor, machinery and 
other kinds of ''capital" are used in production, 
and since such "capital" can only be accumulated 
by saving, we may regard saving (or "waiting") 
as one of the three primary factors of production, 
the other two being labor and land. And we may 
widen our concept of cost of production so as to 
include consideration of saving. We shall then 
say that the cost of production of wheat, for 
example, is the amount of corn or other goods 
which the same labor, land and saving could pro- 
duce if devoted to such other line and which 
must therefore be sacrificed if the wheat is 
produced instead. 



The Value of Land 

The value of land — and of some other goods not 
now reproducible, such as original Greek statuary 
— has little or no relation to cost of production. 
Land has no cost of production (though there is, 
of course, a very little "made land") in the sense in 
which we have used this expression. The amount 
which purchasers will pay for land is not, 
practically, limited by any alternative they may 
have of producing some of it themselves, nor is 
the amount that sellers will take at all determined 
by any corresponding consideration of other 
rewards which the labor of its production might 
have brought them, since there is, for land as 
such, no such labor of production. Land has a 



Ultimate Determinants of Value. 71 

value based on its earning power,-^ but this value 
is neither directly nor ultimately fixed by any 
cost of production. 

§ 7 
Joint Demand and Joint Supply 

Two cases of value, sometimes called special 
cases though really, perhaps, more usual than the 
more simple case, remain to be cleared up. One is 
the case of joint demand; the other is the case 
of joint supply. 

Demand for the services of railroads may be 
mentioned as a case of joint demand. Demand 
for rail transportation involves, indirectly, demand 
for rails, ties, ballast, engines, cars, services of 
engineers, etc. All of these together are necessary 
for transportation. Demand and supply (or, in 
some degree, government regulation) fix a set of 
rates (prices) for transportation and these rates 
go out indirectly as payments for the various 
services by which the service of transportation 
is made possible. If any one thing needful for 
transportation is scarce, e. g. ties, the price of 
that thing may go very high indeed without 
raising the price of transportation (dependent on 
so many prices) in anything like the same degree, 
and therefore without greatly diminishing the 
demand for transportation. The different articles 
and services included in joint demand may change 
greatly in price relatively to each other, according 
to their relative costs of production, without chang- 



20 



Cf. Chapter VI, §2. 



72 Earned and Unearned Incomes. 

ing the price of or the demand for the desired 
combined service.-^ 

Joint supply is the familiar case of by-products. 
Two or more things are in part produced by the 
same process. Thus, coke and coal gas are both 
produced by the process of abstracting gas from 
coal. The expense of mining the coal and the 
expense of abstracting the gas are then joint 
expenses. These expenses would have to be met 
either to get the coal gas or to secure the coke. 
Another example, commonly given, is that of wool 
and mutton. These are joint products of the 
sheep raising industry. The expense of sheep 
raising is a joint expense, an expense which must 
be met to secure either the wool or the mutton, 
but which, if it is met, makes it possible without 
great additional cost, to get both wool and mutton. 
In this case, as in most cases of joint supply or 
joint cost, not all of the cost is joint. The cost 
of shearing is not joint but is necessary only 
to get the wool. The cost of slaughtering is 
necessary to get the mutton. The expenses of 
marketing are also, for the most part, special. 
But a considerable part of the total expense is 
joint. 

In the case of joint supply, a part of the expense 
of production, i. e. the part which is joint, will 
be covered in varying proportions in the price of 
the several goods so produced, according to the 

21 Cf. Marshall, Principles of Economics, sixth edition, London 
(Macmillan), 1910, pp. 381-383, and Taussig, Principles of Econo- 
mics, second edition, New York (Macmillan), 1915, Vol. I, pp. 231- 

224. 



Ultimate Determinants of Value. 73 

relative demand for such goods." The producers 
must, in the long run, receive, from all the goods 
jointly produced, the average return on the labor 
and capital applied to production of such goods. 
But any one of the by-products may, if demand 
for it is small, sell for little more than enough to 
cover the special expense of producing and 
marketing it. Thus, in the case of wool and 
mutton, the prices received for both must cover 
the cost of marketing, slaughtering and shearing, as 
v^ell as the cost of maintaining the flocks; but the 
price received for the wool alone, in case the 
demand for wool is relatively small — or for the 
mutton alone, if the demand for it is small — need 
cover little more than the special cost of produc- 
ing and marketing the one product, leaving the 
purchasers of the other to pay the part of the 
cost which is joint. In consequence of this fact, 
an increased demand for mutton would tend to 
lower the price of wool. For it would encourage 
sheep raising and would thus increase the amount 
of wool. But the larger amount of wool could 
not be sold (for we are not assuming a greater 
demand for it) except at a lower price. Hence, 
the price would fall, and, since the process of 
producing the mutton involves, also, the prelim- 
inary step of producing the wool, it would be worth 
while to sell the wool for the cost of shearing and 
marketing, rather than not sell it at all.^^ 

22 See J. S. Mill, Principles of Political Economy, Book III, 
Chapter XVI, §i. 

23 For a discussion of whether railroad rates are an example of 
joint cost, see the author's Principles of Commerce, New York (Mac- 
millan), 1916, Part III, p. 9, footnote. 



74 Earned and Unearned Incomes. 

§ 8 
Summary 

In this chapter we have endeavored to trace the 
influences bearing upon value and price back to 
their more remote origins. Since supply of one 
good means demand for others, it appeared that 
there could not be a general oversupply of all 
goods but that an oversupply of some means 
merely a relative undersupply of others. Demand 
for any good involves a willingness to sacrifice 
something in order to get it. The sacrifice may 
take the form of extra effort or of giving up 
some alternative good. At any price the demand 
of each purchaser is for so much of the good that 
another unit of it would be worth no more than 
the price paid in money, and, therefore, in labor 
or in other goods. A high price of any article 
would tend to reduce demand for it not only by 
discouraging its consumption but also by causing 
many who would else be purchasers of it to 
become instead producers of it. In this sense, 
demand for any good depends upon its cost of 
production. Purchasers will not, in the long run, 
pay more for a good than the amount of other 
goods which the same productive effort and other 
sacrifice will produce. The prices at which there 
may be demand for a non-reproducible good, 
are not thus limited. 

The supply of any good depends upon the price 
offered, and upon the intensity of demand of the 
producers of it for the other goods they indirectly 
get through its sale. A higher price will not of 
necessity always cause producers to work longer or 



Ultimate Determinants of Value. 75 

harder at their task. It may encourage them to 
reduce their hours of work since it may enable 
them to earn more than before in fewer hours 
than before. But a higher price will usually in- 
crease the amount of any good produced since it 
will usually increase the number of persons pro- 
ducing that good by diverting some from other 
lines. Supply, therefore, depends upon cost of 
production except, of course, in the case of non- 
reproducible goods, of which, with some qualifica- 
tion, land space is an example. To get more of 
anything produced may require a higher price 
because persons relatively ill adapted to its pro- 
duction or to whom the work is comparatively 
distasteful must be drawn in, because poorer 
land must be used, because land already so used 
must be used more intensively, and because land 
relatively better fitted (at the old relation of 
prices) for other production must be drawn in. 
The cost of production of any good comes 
finally to be expressible as the amount of some 
other good or goods which the same labor, land 
and saving could produce. The cases of joint 
demand and joint supply were found to involve 
some intricacies but no new fundamental principle. 



CHAPTER III 
THE CAUSES OF INTEREST 

§ 1 
The Factors of Production 

The factors of production may be said to be 
land, labor and capital.^ Some writers mention 
business leadership as a fourth factor, but this 
since it involves mental effort and requires direct- 
ing ability, may properly enough be regarded as 
a kind of labor. Other writers class land with 
capital, but we have already found reasons to 
consider land separately from goods produced by 
mankind,- and shall have reason further to press 
the distinction, later on.^ 

Let us now consider what fixes the amount of 
each factor of production. As to land, little need 
be said. Its amount is practically fixed by nature. 
There is, to be sure, some "made land." The 
people of Holland have dyked back the North Sea 
and made cultivable a considerable area which 
would otherwise be largely under water. There 
are doubtless other cases where land is "made" 
by human effort, though not on so large a scale. 
But it is nevertheless almost absolutely true that 

1 Since capital depends upon productive effort plus saving, the 
ultimate factors are land, labor and saving (or waiting). Cf. 
Senior, Outlines of the Science of Political Economy, fifth edition, 
pp. 58-60. 

2 Chapter II, §§2, 3 and 6. 

3 Chapter IV, §§3 and 5. 

(76) 



The Causes of Interest 77 

the amount of land space in existence is fixed by 
nature and cannot, practically, be changed by man. 
The barrier to increase of available land space 
is not absolute. It is conceivable, for example, 
that shallow parts of the ocean might be filled 
in by dredging sediment from other shallow parts. 
But the expense would almost invariably be 
prohibitive, certainly in relation to the expected 
gain. In other words the (marginal) cost of 
production of land, if it were necessary to produce 
much of it in the way suggested, would be tre- 
mendously high, and land would have to get tre- 
mendously scarce and high in value before it 
would be worth while so to produce it to any 
appreciable extent. The value of land space, 
therefore, as pointed out in the last chapter,* 
cannot be said to depend in any marked degree, 
if at all, on the cost of production of land. Nor 
can the amount of land space in existence be said 
to depend on the amount for which land will sell 
or upon the profits which land ownership yields. 
Thus land space differs from most other goods in 
the relative fixity of supply, for a higher value of 
other goods or a higher profit from their use, or 
a greater efficiency of labor, may affect the supply 
of such goods considerably. Though land fertility 
may be increased by labor, land space practically 
cannot be. So far as the fertility of land is 

*§6. For further discussion and elaboration of the various pointi 
of difference between land and capital, and for critical considera- 
tion of views inconsistent with that presented in this book, see 
Chapter IV, §§3 and 5, and Chapter VI, §§i, 2, 3 and 8. 



78 Earned and Unearned Incomes. 

given by nature and is not, practically speaking, 
dependent on the efforts of man for its mainte- 
nance, we shall class it with land space as a 
part of the factor land. So far as it is a produced 
fertility, we shall regard it as capital. 

§ 2 

The Accumulation of Capital 

Land may be regarded, in a sense, as one of the 
tools man has to work with, a tool furnished by 
nature. Man's other tools, though drawn from the 
land, are furnished, in a sense, by himself. He 
constructs them and fits them to suit his needs. 
With these tools we should include such improve- 
ments on the land as foresting, draining, fertiliz- 
ing, fencing, clearing, leveling, etc., as well as the 
buildings placed upon the land. All of these things 
can be increased by human effort and are not 
fixed in quantity in the same degree as land. 

Among the things produced by men, it is neces- 
sary to distinguish those made for personal 
pleasure or practically immediate consumption 
and those made as steps towards future consump- 
tion, such as accumulated stocks of goods, build- 
ings, tools and machinery, etc. The former we 
call consumptive goods, and the latter we call 
capital. While it may be hard to determine, in 
some borderline cases, to which class certain 
things belong, the general distinction is sufficiently 
clear for use in our further discussions. 

What determines the extent to which such 
capital will be accumulated? Several influences 
are important. First, may be mentioned the 



The Causes of Interest 79 

efficiency of production. In a community where 
wealth is easily produced, a large amount can be 
accumulated with less deprivation of immediate 
wants than if productive effort were less efficient. 
Rich natural resources, well-trained and intelligent 
labor, high capacity for work, all tend to facilitate 
accumulation. And the fact that accumulation 
has taken place in the past and that, as a conse- 
quence, the community has more and better 
machinery of production, certainly tends to make 
productive effort more effective and so to make 
further accumulation easier. 

In the second place, the amount of capital de- 
pends upon personal characteristics of the members 
of a community, upon the extent to which they 
desire to save and are willing or anxious to deny 
themselves present gratifications for the sake of 
the future of themselves or their children, or other 
dependents.^ 

§ 3 

The Productivity of Capital 

We are now ready to begin our discussion of the 
distribution to different economic classes, of what 
the industrial and commercial processes produce 
for human use and consumption. First among 
the shares received, we may consider the interest 
on accumulated capital. This has been said by 
some writers to be due to the productiveness or 

5 Perhaps the best statement of the influences that lead to and 
that retard accumulation is to be found in Fisher, The Rate of 
Interest, New York (Macmillan), 1907, Chapter VI. John Rae, 
Bohm-Bawerk and others have also developed this subject. 



80 Earned and Unearned Incomes. 

productivity of capital, and by others to be a 
consequence of the fact that to get an accumula- 
tion of capital there must be a degree of absti- 
nence practiced or that an inducement must be 
offered to get men to sacrifice present consump- 
tion for future. Let us examine these alleged 
causes of interest with a view to determining 
what their significance may be for our problem. 
That capital is productive in the sense that we 
can get more with it than without it, is generally 
recognized. It is recognized simply because 
experience indicates that it is a fact and not by 
virtue of a priori reasonings. And experience 
indicates it to be a fact, not in the sense that 
every possible mode of production with capital 
is more effective than production without it, but 
only in the sense that, given any stage of knowledge 
of how to use capital, production is more efficient 
if we can get a certain amount of capital to use 
in the understood tvays than if we can not. No 
one would seriously contend that every use of 
machinery or other capital was advantageous. 
It is entirely probable that we often use 
valuable (in the sense of having high cost) and 
complicated machinery to do work that could be 
as effectively done without it or to do work not 
worth doing. We construct buildings of stone in 
places which are soon deserted and where, there- 
fore, frame buildings — though less enduring — 
would be more economical. And where we do use 
capital advantageously, it often is true that an 
attempt to use it on a much greater scale would 
not be worth while. To lengthen the production 
process by introducing more steps is not desirable 



The Causes of Interest 81 

without limit. The thought will perhaps occur 
to the reader, not only that capitalistic or ''round- 
about"® production processes either may or may 
not be advantageous, but also that if those which 
we use are, for the most part, advantageous, this 
is because we would not intentionally use them if 
they were not. On the hypothesis that present 
pleasures are always preferred to future ones and 
future discomforts to present ones, this view is 
justified. But it might easily be the case that a 
person or group of persons would rather do work 
today which should find its fruition years hence 
when needs are great and strength is small than 
to do the work now for a like present reward, or 
later for a later reward.^ We cannot definitely 
assert, therefore, that a long time process of 
production, involving the making of machinery or 
the planting of trees or some other early labor as 
an intermediate step to getting a future product, 
would never be chosen in preference to a short 
time process, unless there were an advantage in 
choosing it from the point of view of a larger 
total product. Often we might find advantage 
enough from saving, in having nature offer us the 
opportunity to store up labor — which it happens 
to be convenient for us to undergo today — until 
a future when its product is more needed.^ Never- 

^ Bohm-Bawerk's expression. See The Posit'we Theory of Capital, 
English Translation, London (Macmillan), 1891, or Positive Theorie 
des Kapitales, Dritte Auflage, (Innsbruck), 1912. 

'^ Cf. Carver, The Distribution of Wealth, New York (Mac- 
millan), 1904, pp. 232, 233. 

^ But unless there were a gain from thus investing, the average 
person would probably simply hoard some indestructible form of 



82 Earned and Unearned Incomes. 

theless, although some kinds of capitalistic pro- 
duction may not profit us, and although we might 
be willing to produce capitalistically to some 
extent without getting a consequent larger return; 
yet that we usually do, in practice, secure a much 
larger product with the use of capital than we 
could secure without it, is a conclusion resting on 
hardly-to-be-denied experience. And so long as 
we can find ways of thus producing capitalistically 
which are gainful, i. e. which yield us more than 
the same effort would yield if a part of the effort 
applied were not first devoted to capital formation, 
we are not likely to waste our time in the many 
(perhaps) possible ways of capitalistic production 
which do not yield a gain.^ 

In connection with our argument that capital 
makes production more effective, the qualification 
should be made that this principle applies as 
logically to the production of noxious drugs, 
burglar's tools and other socially undesirable 
articles or services, as to the production of 
socially desirable goods. Capital becomes altogether 
beneficent only if all possible anti-social uses of it 
are prohibited. Again, roundabout or capitalistic 
production must be held to include activities 
other than the construction of what is ordinarily 
called material equipment. It includes activities 
which work out their long runs effects through 

wealth such as gold. Possibly an iron-clad government guarantee of 
the return of each person's capital in any form on demand would be 
equally as satisfactory as hoarding, to some. 

9 This is not to deny that we will use capital to keep (store) the 
products of one season for use in another, though the capital so 
used increases only utilities and not material goods. 



The Causes of Interest 83 

changes wrought in men's minds. Thus, it may be 
regarded as including education pursued for the 
purpose of increasing one's earning power. It 
includes also such activities as the bribery of 
public officials and the attempt, by misleading 
public sentiment and by building up political 
machines, to get thereby, for those pursuing such 
policies, profitable contracts and other advantages 
in the future, at public expense. A business con- 
cern which, by thus taking measures and making 
expenditures to secure for itself the opportunity 
of getting profitable if dishonorable business, has, 
so far as its purposes are concerned, increased its 
capital as much as if it had increased its invest- 
ment in buildings or machinery and is, from its 
point of view, engaged in roundabout or capital- 
istic production. 

It is to be emphasized that capitalistic produc- 
tion is time-using production. Instead of plucking, 
as we need it, the wild grain, and so keeping an 
interval of but minutes or even seconds between 
effort and the satisfaction of needs, we sow or 
plant the grain months before we expect to reap it ; 
we build barns which — though we may soon 
begin to use them — we shall not have finished 
using, perhaps, at the end of half a century; v/e 
manufacture plows, harrows and reapers which 
will not yield us, for many years, all that it is in 
them eventually to yield; we construct factories 
for the manufacture of these implements, factories 
which, when their builders have long since ceased 
to build, will still be turning out implements of 
agriculture for long continued future use; we 
build bridges, lay tracks, erect stations and con- 



84 Earned and Unearned Incomes. 

struct locomotives, any or all of which can not, 
ordinarily, yield us this year or next an advantage 
at all comparable to their cost — i. e. to the 
advantage which our effort might have brought if 
devoted to the satisfaction of more immediate 
needs — but which, in the long run, pay for them- 
selves often several times over. In all of these 
eases we interpolate a long period of time between 
the putting forth of effort and the receiving of its 
entire product, though in some of the cases a 
small part of the resulting product is enjoyed 
early. 

Production may be made more capitalistic by 
increasing the length of time of waiting between 
effort and enjoyment of the results of effort, or by 
increasing the proportionate amount of effort 
(more accurately, perhaps, by increasing the 
proportionate amount of labor, of land, and of 
available tools) which is directed to remote instead 
of comparatively immediate ends. In either case 
there would be an increase in the average time, 
all work considered, between the putting forth of 
effort and the receiving of its fruits. Thus, the 
time elapsing between effort and the receiving of 
the entire reward of the effort is increased when, 
instead of making frame buildings for factories, 
we construct the factories of structural steel. The 
buildings are more permanent; a longer time 
elapses before they have rendered all the service 
of which they are capable. But we also increase 
the roundaboutness of production if, without 
lengthening the production period for any one 
factory, we divert a part of our labor force, 
previously occupied in utilizing existing equipment, 



The Causes of Interest. 85 

into the work of building an additional factory. 
It may easily be that all of the labor employed in 
(say) shoe production could be employed in keep- 
ing up and in operating the existing factories and 
machinery; and that nevertheless production would 
be larger if some of this labor was used for the 
building of another factory, since thus there 
would be more space and larger equipment per 
operator. Such diverting of a part of shoe-pro- 
ducing effort to the addition of shoe-producing 
equipment would be, no less than to make equip- 
ment more durable, an increase in the round- 
aboutness of production. 

So, also, the diverting of coal mines which had 
been used for the production of coal to run the 
machinery of an existing shoe factory, into the 
production of coal for the smelting of iron and 
for the making of structural steel to be used in 
building an additional shoe factory, would mean a 
use of the coal mines, as well as of the labor of the 
operators, in a more roundabout way than before. 
Again, the diverting of land from use as pastures 
and for the production of hides to be used in shoe 
making, into forest growing and the production of 
lumber for the building of shoe factories would 
be, in respect to such land, an extension of the 
roundaboutness of production. Such a change to 
greater roundaboutness in the production on 
exceptionally well located (or otherwise good) 
land would be likely to mean a larger change in 
the degree of roundaboutness of productions^ 

lojt Js^ of course, assumed at this point, that the land in question 
is reasonably well adapted to either use. 



86 Earned and Unearned Incomes. 

than a corresponding shift in the kind of produc- 
tion to which inferior land is put. Still again, 
the productive use of both land (the site) and 
capital (the building) is made more roundabout if 
a factory intended for the manufacturing of shoes 
is used for the making of shoe manufacturing 
machinery. Any parts of the product which may 
be attributable to the land or to the capital as 
well as what is attributable directly to labor, 
then take more largely the form of capital or in- 
struments of further production than before and 
less largely the form of consumption goods. 

There seems, however, little point to speaking 
of capital (i. e. produced equipment goods) as 
being diverted to greater or less roundaboutness 
in production since capital is itself but a stage in 
the roundabout application of labor applied to 
natural resources. Capital is an intermediate good 
and a derivative of more ultimate factors. To di- 
vert capital to more roundabout production is really 
to bring it about that the original labor of con- 
structing this capital was more largely roundabout 
than it otherwise would have been and that the 
land space utilized in the process of its production 
was also devoted to the securing of more remote 
ends. Let us conclude, then, that the roundabout- 
ness of production is increased when labor is di- 
verted from less to more roundabout processes and 
that this change is greater when the labor is work- 
ing on sites which yield a surplus or rent above 
wages,^^ since this surplus then, as well as the 

11 Providing, of course, that a surplus is produced when the land 
is devoted to the more roundabout process. 



The Causes of Interest. 87 

(marginal) product of labor, takes the form of 
production goods. 

The roundaboutness of production has been in- 
creased, to use another illustration, by the building 
of railroads. Let us suppose two towns, A and B, 
200 miles apart. In the absence of better means 
of transport, goods are carried from the one town 
to the other and different goods returned in trade, 
by men acting as carriers. It takes, let us say, a 
week, for twenty men to carry a ton of goods from 
A to B. Omitting, for the present, considerations 
regarding the raising or manufacture of these 
goods, we may say that only a v/eek of labor pre- 
cedes the consumption of the goods and only two 
weeks precedes a complete trade and the con- 
sequent consumption aimed at by the people in 
both towns. And all of the benefits towards which 
the two weeks of labor were directed follow with 
relative quickness the putting forth of the effort. 
If, however, instead of carrying the goods on their 
backs, the carriers make carts or wagons and 
domesticate animals to draw these, their ac- 
complishments may be much greater; but the 
period during which these accomplishments are 
realized will be, in relation to the period of effort, 
m.ore deferred than before. A wagon may, indeed, 
be made in a week's time and by the end of another 
week it may have carried more goods between the 
two towns than the maker could carry, without it, 
in a month or more. But the wagon will not, in a 
week, be worn out. On the contrary, it will pre- 
sumably be in condition for use during many later 
weeks through all of which the service rendered 
by it is largely a result of the labor put forth in 



88 Earned and Unearned Incomes 

making it. The rewards of that labor (of making 
the wagon) are, therefore, on the average, more 
deferred than the rewards of the labor of carrying 
when wagons were not used. Suppose, next, that 
a railway is built between the towns. The build- 
ing requires three years, during most of which 
period the rails can not be used to carry goods. 
At the end of the three years, the possible trade 
may be, indeed, much greater than before and the 
carriage of goods swifter; but the labor of build- 
ing the railroad will still be contributing to com- 
munity welfare long after those who built the 
road have ceased to be able to lift a spade or carry 
a tie. Surely the length of time elapsing between 
effort and the totality of the reward of that effort, 
or even the earlier half of the reward of that 
effort, has been tremendously increased. By no 
means all improvements in the processes of pro- 
duction are of the time-lengthening character. But 
it does appear to be true that many of them are 
so. Our orchards, our irrigated farms, our stone- 
paved streets and concrete sidewalks, our buildings 
of structural steel, our complicated machines of 
steel and iron, our railroads, and our great steel 
ocean-going vessels, — all involved for their con- 
struction labor the fruits of which are not enjoyed 
in full until long years beyond the time when the 
labor was put forth. 



The Causes of Interest 89 

§ 4 

Capital Accumulation versus Marginal Capital 

Productiveness 

But although the more roundabout processes of 
production seem to be — at least, those that we 
actually do follow — clearly advantageous to us, 
yet our gain seems to be proportionately smaller 
as we thus utilize proportionately larger amounts 
of labor. To add to the community's equipment 
a certain number of railroads, buildings, machines, 
fruit orchards, etc., may add immensely to the 
product we can hope to realize from our efforts, 
while a further amount of labor devoted to the 
still greater increase of such equipment would be 
of diminishing advantage, and a still further de- 
voting of time to such a purpose of yet smaller 
benefit. A single railroad between New York and 
Chicago is tremendously advantageous as compared 
with none at all. A second railroad may be of 
great importance but is less nearly indispensible. 
A third and a fourth may be desirable enough to be 
worth building. But there comes a point of rela- 
tive sufficiency of such railroads, beyond which it 
pays better to devote our labor to other purposes. 

Again, while it may be far better to have one 
or more railroads between two points than not to 
have them, there will be, perhaps, a less propor- 
tionate gain from the added expenditure necessary 
to make the lines relatively straight. It is much 
better to have a winding road than no road at all. 
A straight and level road might involve tunneling 
through mountains and the bridging of gulleys 



90 Earned and Unearned Incomes 

and might be, therefore, immensely more expen- 
sive in initial cost; while yet it might, eventually, 
be labor saving. In other words, a given large 
amount of effort is likely eventually to accomplish 
more if the straight road is built. But the per 
cent gain may diminish with each such improve- 
ment. 

The addition of stock, buildings and machinery 
to a farm reaches, in time, a point beyond which 
it is not worth while to go. A barn may seem 
almost indispensable. That more time should 
be devoted to its building, making it larger, or 
that two barns should be built, may be desirable 
for the sake of having a protected space for 
the bumper crops of exceptional years; but a 
second barn is of much less importance than a 
first and may be said to bring a diminishing 
advantage. Even the fact that part of such a 
crop must be stacked may not be a sufficient reason 
for the building of the larger or the second barn, 
in view of alternative opportunities for the em- 
ployment of the necessary labor. Likewise, a 
mowing machine, though requiring more initial 
labor to make and, therefore, a much higher 
price to buy, is immensely to be preferred to 
several scythes. A second mowing machine is 
of less advantage though the gain from having 
it also may be considerable. Sometimes the 
possession of the second machine may make 
possible the getting in of a crop during a short 
sunny period, or the use of a team which cannot, 
for a few days, be otherwise used to advantage; 
or the second machine may temporarily be the sole 
resource if the first happens to be, for any rea- 
son, out of commission. The gain from a third 



T?iE Causes of Interest. 91 

machine would be negligible and from a fourth 
there would perhaps be no gain at all. Again, 
to take another illustration from agriculture, 
the grain product which a given amount of labor 
can secure, will be greater if cradles are used for 
reaping than if sickles are used, and very much 
greater if a reaping machine is used. Or we 
may say that a given grain product can be realized 
from a given land area with a smaller expenditure 
of labor when the improved machinery is used 
than when reaping is done with the tools of an 
earlier generation. And still further gain, though 
perhaps less gain proportionally, is realized from 
the use of modern reapers which bind the grain 
as well as cut it. Nevertheless, there is un- 
doubtedly a limit, though perhaps an elastic one, 
as to both quantity and quality of machinery, 
beyond which it is not worth while to pass. 

But if, in any community, only a limited 
amount of effort (as well as of land and equip- 
ment already available) can be devoted to the 
construction of equipment for production, con- 
sideration must be given to the fact that some 
equipment is more important than other. The 
farmer can get along without a reaper better 
than without a barn. He can get along without 
a silo better than without a reaper. The railroad 
can get along without stations or with inadequate 
stations better than it can get along without a 
track, engines and cars. The city can get along 
without stone paving on its streets better than 
it can get along without any streets at all.^^ 

^2 It is not at all obvious as Cassel appears to suggest that it is 
{The Nature and Necessity of Interest, London — Macmillan — ,1903, 



92 Earned and Unearned Incomes. 

We conclude, then, that the gains from round- 
about production tend to diminish as such pro- 
duction is extended, and tend to diminish whether 
the extension of roundaboutness takes the form 
of the addition of equipment beyond the most 
necessary kinds, or of an additional amount of 
equipment of all kinds, or of more expensive 
quality of equipment. In fact, when the amount 
of effort, land and tools available for the pro- 
duction or maintenance of desirable capital equip- 
ment is greatly limited, the effect is likely to be 
as apparent in the making of poorer and cheaper 
equipment as in a diminution in the number of 
equipment implements.^^ The reason is that the 

pp. 31 and 55) that the diminishing return to capital as capital is 
increased, is related to the law of dimishing returns from land. 
It is true enough that as the application of labor to land increases, 
after the point of diminishing returns is reached, the returns yielded 
to the further applications of labor become relatively smaller, and 
this is doubtless equally the fact whether the labor is directly or 
indirectly (i. e. by first being devoted to capital making) applied. 
But it does not follow that the net per cent gain of roundabout 
over direct production will be any less because population is large 
in relation to natural resources and because the returns to both 
roundabout and direct production are therefore small. To express 
differently the same thought, if the value of capital is measured by 
the other goods which the capital-forming labor (and other factors 
of production) could have produced as an alternative, the per cent 
return on this value is not necessarily any lower because of a lower 
margin of production on land. The correct opinion appears to be 
clearly stated by Jevons, The Theory of Political Economy, fourth 
edition, London (Macmillan), 1911, p- 255; Cf. also p. 314 (Ap- 
pendix III) . 

13 This view is clearly held by J. B. Clark although he seems not 
to have thought it necessary to present the argumentative defense 
of it which follows above. See The Distribution of Wealth, New 
York (Macmillan), 1899, pp. 174-177. 



The Causes of Interest. 93 

competition of employers for the use of equipment 
will result in relatively poor equipment for the 
use of nearly all labor rather than in splendid 
equipment for some labor and none at all for the 
rest. A small amount of the poor equipment 
yields greater advantages to those enterprisers 
who would otherwise have none — and they can 
therefore bid higher for it — than a corresponding 
addition to the quality of their equipment would 
yield to employers who might be especially favored 
with the more costly buildings, machinery, etc., 
but who could not, because of the limited amount 
of this capital, employ all the community's avail- 
able labor. In other words, although the more 
costly equipment would presumably be more durable 
or otherwise superior, yet if the necessary labor 
of its construction would be so great as to mean 
an inadequate number of implements for the labor 
force of the community, the bidding for the use 
of capital of those who might otherwise have none, 
would prevent putting all available capital value 
into the more durable or otherwise more expensive 
form. Let us suppose a community for the use 
of which an amount of capital is available large 
enough to house all its industries in frame build- 
ings but sufficient to house only half of them in 
buildings of structural steel and concrete. Though 
the more substantial buildings would perhaps 
have a potential life more than twice as long, yet, 
in view of the assumed existing situation, it would 
not be desirable to choose them. The extra invest- 
ment of labor that would have to be made to con- 
struct a given building in the more substantial 
way, could be used to get a second of the less 



94 Earned and Unearned Incomes. 

substantial buildings along with the first; and 
this would be the more worth while investment, 
until the community became richer and could 
spare labor from other activities to construct a 
relative sufficiency of the more expensive build- 
ings.^* An additional cheap building would add 

14 J. B. Clark, criticizing Bohra-Bawerk, says ( The Distribution 
of Wealth, New York — Macmillan — ,1900, p. 138) that adding to the 
length of the production periods "does not necessarily add to the 
amount of capital in existence," that, if it does not, "^the increase in 
the average length of the periods does not have the effect that the 
brilliant Austrian economist attributes to this lengthening, for it does 
not reduce the rate of interest" which might "be high when the 
periods were long and low when they were short" and that it is 
"when the quantity of permanent capital increases that interest falls." 

Professor Clark's theory, however, is more easily to be reconciled 
with that of Bohm-Bawerk than he appears to realize. In the first 
place, a lengthening of production periods distinctly tends towards 
an increase of the amount of capital. Consider the case of a man 
who is about to work for 100 consecutive days. If the average period 
of production is short, he may spend 5 days in making a capital in- 
strument which yields its services during the next 5 days during 
which the man is producing another to take its place, and so on 
throughout the 100 days. There will, then, at no time be more than 
5 days of labor stored up as capital. But the production period 
may be much longer. Thus, it may require 50 days to make an in- 
strument which yields its services during the next 50, during which 
it is replaced. In this case, although no more days than in the other 
are devoted to capital production, there is always — after the first 
50 days — 50 days of labor stored up in capital. The amount of 
capital in existence at any one time is much larger. (Elsewhere 
— pp. 293-295 — Clark himself recognizes this principle.) Assum- 
ing the amount of saving done in a community to be such as to cause 
many to engage In such longer production processes and assuming 
that the increased length of period does not correspondingly increase 
the product, we should have to conclude that the rate of interest would 
be lower. 

In the second place, it is just because an indefinite increase in the 
length of the production periods will not correspondingly increase 



The Causes of Interest. 95 

much more to the efficiency of labor in such a 
community than greater durability of a building 
certain to be constructed in any case. Hence an 
employer of labor would prefer to use what capital 
he could get, in the former way. Hence, also, 
prospective borrowers of capital desiring to use 
it in the former way could afford to pay more for 
its use. 

It should be emphasized that the use of capital 
does not necessarily mean a progressively larger 
product, does not mean, for instance, a larger 
product next year than this. All it means is a 

the returns to labor, that so much labor is devoted as is devoted, to 
the production of the shorter-lived capital instruments and that the 
marginal productivity of these shorter-lived instruments is reduced 
to a comparatively low return- Suppose the average production 
period to be a year and capital to yield, at the margin, lo per cent. 
Increased saving might, by increasing capital, reduce the marginal 
gain from using it to (say) 8 per cent- But if it should meanwhile 
appear that these savings could be used in a three-year roundabout 
process yielding at the rate of lo per cent a year or 33.1 per cent 
(compounding) for the three years, the one-year instruments would 
be less constructed and would become comparatively scarce. Hence 
their marginal product would become as great as 10 per cent and 
Interest would become 10 per cent. If however, the lengthening of 
the production period would not correspondingly increase the pro- 
duct, this lengthening would be less resorted to and more one-year 
instruments would be constructed. Hence, interest might fall to 
9 or 8 per cent. Even, therefore, if we were to regard increased 
length of production periods as not involving any increase of capi- 
tal more than would be involved in devoting the same labor to the 
production of short-time capital instruments, and even if we were 
to regard the rate of interest as being fixed directly by the marginal 
productivity of these short-time instruments, the possibilities of re- 
sorting to roundabout production would still have to be taken ac- 
count of as conditions determining the amount of short-time capital 
that would be constructed. 



96 Earned and Unearned Incomes. 

larger product next year than next year's product 
would be if capital were not used. We may choose 
to produce capitalistically up to and not beyond a 
certain limit. If we so choose, we may go on, 
year after year, producing the same amount of 
wealth and maintaining an unchanging standard of 
living, but getting, each year, more than we could 
get with corresponding effort, were our methods 
of production less capitalistic. 

§ 5 
Saving or Abstinence in Relation to Interest 

In order that the more productive roundabout 
process may be followed, there must be saving. 
For the roundabout process means, as we have 
seen,^^ productive effort the full reward of which 
is greatly deferred. The labor of building a rail- 
road must be fairly well completed before the 
resultant services can begin, and not for many 
years are these efforts rewarded with all the 
services towards which they were directed. Y3t 
the persons who build the railroad must have food 
and clothing while they are at work. In like 
manner, the labor of building a factory for the 
making of agricultural machinery may be an 
initial step in the securing of wheat and, therefore, 
in the securing of bread. The persons who per- 
form this labor must have food and presumably, 
bread, yet the labor does not immediately produce 
bread. There must be bread at hand, or securable 
by the builders during the period of their building, 
else the work can not go on. 

15 §3 of this Chapter (III). 



The Causes of Interest. 97 

The fact that subsistence must be available to 
make possible the prosecution of roundabout 
production may mean and probably does mean that 
there are at hand accumulations from the past. 
These accumulations will not be mainly, perhaps, 
stores of wheat, etc., from the last harvest 
(although in winter and spring such stores must 
be considerable) so much as accumulations of 
machinery, draft animals and buildings which 
facilitate production of wheat, etc., as needed. 
But whether roundabout production necessitates 
past saving or not, it certainly necessitates saving. 
The saving may be present saving of other 
members or classes of the community. Thus, the 
building of a factory for the manufacture of farm 
implements may be possible because the producers 
of wheat are raising more wheat than they can 
use, saving a part of the money derived from the 
sale, and investing this money in a company 
organized to manufacture agricultural machinery. 

It will be advantageous to trace out in greater 
detail the interrelations of savers (who may or 
may not be laborers) and the laborers employed 
by the savings. The wheat raisers (assuming them 
to do the saving) produce wheat in excess of their 
own needs; they sell this excess on the market 
and it becomes a part of the stock^^ of usable 
wealth of the community. The money they receive 
may be regarded as so many tickets entitling them 
to draw from this stock a value equal to what 
they have put in. But they do not spend all of 

^^ The concept here is that of a stock of wealth which is contin- 
ually being drawn from and replenished. 



98 Earned and Unearned Incomes. 

this money in withdrawing consumption goods. 
A part of the money is saved. The saved money is 
invested in the stock or bonds of the agricultural 
machinery company (either directly or through the 
intermediation of a broker or a savings bank) . The 
company then uses this money to hire labor to build 
its factory. The laborers employed to build, in 
spending their money for bread and other necessary 
or desired goods, are taking from society's stock and 
using up, the goods which the saved money repre- 
sented.^^ While doing this, however, they have pro- 
duced a factory.i^ Therefore the persons who did 
the saving and investing now have ownership in 
the factory instead of having had and enjoyed the 
other wealth which they might by now have 
consumed, had they chosen the alternative of not 
saving. 

The same principle applies if, instead of adding 
new capital, the savers merely keep up the old 
capital. Thus, the owner of a shoe factory is 

^'^On the hypothesis that the saved money is hoarded and not 
spent, prices will tend to fall, all the goods which the saved money 
represents may be consumed by others than the savers or their (in- 
direct) employees, these others being able to buy more goods be- 
cause prices are lower, and the stock of goods in society will not be 
increased by the saving. Then if, years after, the savers or their 
descendants endeavor to expend this money, prices will rise and 
the consumption of others will be curtailed. Those who have saved 
or their descendants or those for whose capital-producing labor they 
are paying, will consequently be securing consumable goods, not so 
much in direct exchange for the goods originally supplied by the 
savers to the social stock, as at the expense of other consumers 
of a later generation, at the expense of consumers who were not 
benefited by the original saving. (Cf. Davenport, Economics of 
Enterprise, New York — Macmillan — , 1913, pp. 338, 339). 

J8 See Mill, Principles of Political Economy, Book I, Chapter V, §5. 



The Causes of Interest. 99 

supposed to get from it, during its life, besides 
interest on its value, enough to replace it when 
it is too old for further use. But this involves 
saving of a replacement fund instead of spending 
for current enjoyment the entire receipts from the 
factory. In like manner the machines used are 
supposed to yield, on an average, enough to re- 
place their value when they are worn out or when 
improvements necessitate scrapping them. A part 
of the shoes produced may be assumed to be used, 
directly or through their equivalents in other 
goods, to maintain the labor occupied in factory 
and machine replacement. The situation is not 
essentially dissimilar when the owner of the 
machines decides to shift his investment. He then 
does not replace these machines but uses their 
earnings in a corresponding way to provide for 
the construction of a different kind of machines 
or of some other form of capital, having uses of 
another sort. Past accumulations, then, with the 
exception of stocks of consumable goods which, 
because of the requirements of convenience or 
because of the seasonal character of their produc- 
tion, must be kept on hand, take largely such 
forms as buildings, roads and streets, railroads, 
bridges and ships, and machinery. (They also 
take, in part, the form of political connections 
and other means of exploitation.) ^^ The labor which 
is engaged in maintaining or in adding to any of 
this equipment is supported the more adequately 
because the accumulations of capital already made 
render industry more effective. Nevertheless, the 

19 See §3 of this Chapter (IH), 



100 Earned and Unearned Incomes. 

support of this labor comes immediately, in large 
part, from current product.^^ And the keeping of 
some labor thus occupied in maintaining or in 
increasing equipment means that a part of economic 
society is devoting a part of its purchasing power 
to such ends instead of consuming as much as its 
possession — or receipt of purchasing power — would 
enable it to consume. 

The discussion of saving and investing has thus 
far seemed to establish the conclusion that savings 
take form as equipment goods by being turned 
over to laborers who, while consuming goods of the 
value of the sums saved, are at the same time 
producing equipment. But the amounts saved 
and thus devoted to the production of production 
goods, are not paid over solely to laborers as 
wages. They are also paid over, in part, to land- 
owners as rent for the use of land applied to the 
production of capital, and to the owners of capital 
now in existence, as interest, in payment for the 
use of this capital in the production of other 
capital. In short, the surplus production of goods 
which we have spoken of as savings, is turned 
over to those ivho oivn or (in the case of their 
own labor) apply the various factors of production 
and may be entirely consumed by these persons; 
but in due time there issues from the cooperation 
of these factors a stock of equipment goods of a 
value equal to the value of the savings consumed. 

It appears, then, that roundabout production is 
gainful but that it involves provision of consumable 

20 Cf. Henry George, Progress and Poverty, Book I, Chapters III 
and IV. 



The Causes of Interest. 101 

goods to those who are engaged in (whose labor 
or whose property is devoted to) such production. 
This means that the persons who provide present 
goods for the consumption of those engaged in 
roundabout production must themselves defer or 
forego, in some degree, present consumption. They 
must ''abstain" from consuming all that they 
might consume. Hence, abstaining or abstinence^^ 
has been regarded as an element in capital con- 
struction, as a factor which must be taken account 
of in a theory of interest. It is to be recognized, 
of course, that a part of this abstinence may be 
undergone by the persons themselves who are 
engaged in roundabout production instead of by 
others who pay them, in which case those engaged 
in roundabout production come to be, to that 
extent, the owners of the capital they produce 
and claimants on its future yield. Evidently 
enough, addition to the capital equipment of 
society requires abstinence somewhere, and evi- 
dently, too, the mere maintaining of existing 
equipment, by replacing capital which wears out, 
involves abstinence from the consumption which 
might be enjoyed were such replacing not done. 

Whether and how far the necessity of abstinence 
operates as a cause of interest must depend upon 
the extent to which it acts as a barrier to saving. 
If most of the people in the world — or in a 
relatively isolated community — were to abstain 
willingly from present consumption, devoting nearly 
all their productive effort to capital formation, the 

21 See Senior, Outlines of the Science of Political Economy, fifth 
edition, pp. 58-60. 



102 Earned and Unearned Incomes. 

supply of machinery and other capital would be 
large, the g-ain from further increase of it would 
presumably be small, and the rate of interest 
would be low. The theorists who have endeavored 
to explain interest by reference to abstinence have 
regarded abstinence as a sacrifice to induce which 
a payment must be made. They have not attempted 
to deny that some saving would be done even with 
no interest payment and, in some cases, have 
taken pains to assert that a certain amount of 
saving would nevertheless be done.^^ But they 
have urged that such saving is not enough to 
furnish all the capital that can be profitably used 
and that other capital can only be had by virtue of 
the receipt or expected receipt of a return upon 
it.23 The "marginal" saver will not save unless 
compensated for so doing, and a man who would 
save something without interest will not save so 
much, will not save the ''marginal''^^^ dollar unless 
remunerated. When a person has already saved 
a considerable sum, has already denied himself 
a considerable amount of present income for the 
sake of larger future income, the better relative 
provision for his future than otherwise and the 

22 See, for instance, Carver, The Distribution of Wealth, New 
York (Macraillan), 1904, pp. 232, 233. 

23 Ibid, pp. 235-245. Bohm-Bawerk, misinterpreting Carver, makes 
the latter say that interest is the result of overendowment of the 
future (saving). See Recent Literature on Interest, translated by 
Professors Scott and Feilbogen, New York (Macmillan), 1903, pp. 
56-62. 

2* "Marginal," above, means marginal when interest is paid. 
There would, of course, without interest or with it, be a margin of 
indifference, and hence a marginal saver and a marginal dollar 
saved. But the margins would be different. 



The Causes of Interest 103 

poorer relative provision for present needs will 
tend to discourage further savings and to dis- 
courage them the more the greater are the savings 
which he has already made. As Professor Irving 
Fisher would put it, the time shape of his income 
stream (whether falling, level or rising) affects 
the individual's attitude towards saving, affects 
his degree of ''impatience."-^ The millionaire 
does not have to practice abstinence, in the sense 
of making a sacrifice, to save large amounts. But 
marginal savings do involve sacrifice and will not 
be made without compensation. Interest, in this 
view, results from a shortage of savings, due to 
the fact that saving means sacrifice of present de- 
sires. We need not, here, defend the thesis that 
this sacrifice means ''pain-cost." It suffices that 
there is a mental state which interferes with 
saving. In the fear that the word "abstinence" 
might connote pain-cost, some economists have 
preferred such term.s as "waiting," "time-prefer- 
ence," or "impatience." The only essential fact 
for the purpose^s — if it be a fact — is that when the 
choice is made between spending and saving, the 
saver — at least some savers for some of their 
saving — would choose to spend were it not for the 
interest. The disinclination to save, so far as 

25 Fisher, The Rate of Interest, New York (Macmillan), 1907, pp. 
95-98. Professor Fisher, however, will admit the abstinence theory 
only if abstinence be not regarded as a cost (Ibid, pp. 43-52). 

26 It is, however, interesting to note that Bohm-Bawerk, criticizing 
Marshall, and endeavoring to imagine a case in which there could 
be no "sacrifice" of abstinence, succeeded in imagining one in which 
the only possible comparison was of present labor and future com- 
modity. See Recent Literature on Interest, pp. 41 and 43, footnote. 



104 Earned and Unearned Incomes 

there is such a disinclination, can be in large part 
accounted for by the fact that, when choosing 
between present and future expenditures, the 
moment of choice is the present. When the future 
becomes the present and the observation of the 
two (if two) significant dates is made backwards 
in time, it may well be that there will appear to 
have been a ''sacrifice" made if and when earlier 
consumption was preferred to later (now present 
consumption), even though such a choice seemed 
the desirable one when made. If, today, it causes 
regret — though it may not always do so — to plan 
for next year's instead of today's enjoyment, so, 
when next year becomes this year, it may cause 
us regret to realize that we chose to have our 
enjoyment last year and, therefore, can not have 
it now. 

We should not hastily conclude, however, if and 
because there are some who will not save except 
at a high interest that high interest has, in 
general, the result of stimulating saving. That it 
does have this result has commonly been assumed 
by economists and is not here denied, but the 
certainty of its doing so is nevertheless to be 
questioned. There are undoubtedly some persons 
who would save more at a rather low rate of 
return on capital than at a somewhat higher 
rate." Let us consider the case of a man who 
wishes to leave to his descendants an income of 
$5,000 a year, which, in his view, will be suflficient 
to their needs. If interest is 10 per cent, an 
accumulated capital of $50,000 will be sufficient 

27 See Cassel, The Nature and Necessity of Interest, pp. 146-148. 



The Causes of Interest 105 

for his purpose. But if interest is 5 per cent, it 
will be necessary for him to save $100,000 in order 
to leave the desired income to his family without 
the necessity of their at any time trenching on 
the capital.-^ He might actually save $70,000 and 
have to expect some using up, by his family, of the 
saved funds. 

That more saving would result or that as much 
saving would result from lower interest as from 
higher seems, however, not probable. In the 
first place, it is fairly likely that a person who 
would save $100,000 when interest was 5 per cent, 
that his family might have a $5,000 income would 
save more than $50,000 if interest were 10%, 
considering the extra income which his family 
might thus secure as more than compensating the 
smaller relative sacrifice. Reversing the form of 
statement, we may say that few persons probably 
would, because of a lower interest rate, save an 
enough larger sum to yield the same annual in- 
come as they would expect to provide if the rate 
of interest were higher. There is, indeed, reason 
to doubt whether the average person would save 
as much in expectation of low interest as if there 
were prospects of large gains from the saving. 
Saving for old age and the saving which is done 

28 It should be unnecessary to point out that, even if this attitude 
were general, there would be a limit to the amount actually saved, 
and a rate of interest would result dependent upon the relation 
between the advantages of the use of capital and the disposition (or 
lack of disposition) to save. Though the supply curve of capital 
or waiting should slope backward, there would still, presumably, 
be some point of intersection with the demand curve, at which point 
interest would be determined. 



106 Earned and Unearned Incomes. 

through life insurance companies, would yield 
less return on the same investment. But let us 
consider the usually larger savings of those who 
endeavor to provide for their families permanent 
funded incomes. Will this type of saving not 
be discouraged? If we assume as an extreme 
limit a zero rate of interest, we have an hypothesis 
of a condition under which no return would be 
yielded on anything less than an infinite sum 
saved.^^ With no funded income within the 
realm of the attainable, might not some who now 
save large amounts, give up the idea of funded 
family fortunes, and live for the pleasures of 
each passing day? And in lesser degree might not 
a very low return, say 1 per cent, have a corre- 
sponding kind of effect? 

In the second place, the possibility of interest 
being realized carries with it a sort of selection. 
Those who have the disposition to save soon find 
themselves realizing interest on their savings 
and thereby acquire additional ability to save. 
Those who have not the disposition to save are 
less likely to gain additional ability to save. The 
higher interest becomes, the more saving can be 
done by those who wish to save, and this fact 
suggests the likelihood of greater aggregate saving 
at higher interest than at lower.^^ 



29 Mathematical processes give zero times infinity as indeterminate. 

2^ Some one may reply that a higher interest means less capital, 
a lower productivity and hence lower wages, with decreased saving 
power of wage earners, even of wage earners who are most ambitious 
to save. But such an argument would entirely miss the point- The 
discussion above in the text has to do with the effect of interest on 
saving and calls attention to the fact that, other things equal, higher 



The Causes of Interest. 107 

In concluding this discussion it may not be 
amiss to call attention to the fact that the condi- 
tions necessary to induce saving might be very 
different in a socialist society in which private 
ownership of the means of production was pro- 
hibited than in an individualistic society. If 
saving is to take place in a democratically govern- 
ed socialistic society, it is necessary that a 
majoTitij be in favor of it. They must be willing 
that part of the society's current labor shall be 
devoted to the production of equipment for 
future needs even though the volume of goods 
available for current consumption is thus lessened. 
Where, on the other hand, saving is done by 
individuals, there will be some saving even if only 
one person out of ten or one person out of a 
hundred is willing to defer consumption. 

interest means more saving in so far as it may add to the saving 
power of those who have the saving disposition- The criticism in 
question — if made — approaches the relations discussed, not from 
the direction of the effect of interest on saving, but from the direc- 
tion of the effect of saving on interest. It assumes that the high in- 
terest which is, in the text, spoken of as probably a cause of 
saving, is a result of lack of saving and therefore of lack of cap- 
ital; whereas for the problem under discussion the high interest 
which stimulates saving must be held to result from inventions or 
some other interest-raising cause not connected with a dearth of 
saving. 

It may be admitted, in passing, that those who save are not al- 
ways doing the wise thing nor those who spend, the foolish thing. 
Saving which is at the expense of good food, fresh air or rest, may 
diminish a man's working efficiency by more than the interest or 
earnings of the capital saved. It may, in some cases, make future 
saving more difficult than if the first saving had not been done. But 
we should hardly conclude that the great bulk of sums saved in- 
volve such offsetting losses. 



108 Earned and Unearned Incomes. 

§ 6 
Summary 

In this chapter our endeavor has been to dis- 
cover the ultimate causes of interest, without, 
however, attempting an explanation of how these 
forces cooperate or how the exact rate of interest 
is determined. By way of preliminary, the factors 
of production were said to be land, labor and 
capital. We chose to include the work of the 
entrepreneur or enterpriser in the category of 
labor. Capital, it appeared in the course of the 
chapter, is not an ultimate factor of production 
but can be resolved into other factors. If we so 
resolve it, our ultimate factors are land, labor and 
waiting (or saving). The owner of land receives 
rent, the owner of capital receives interest (the 
return on waiting or saving), the laborer receives 
wages. 

Capital is produced by labor applied to or on 
land, usually with the assistance of previously 
produced capital. Analysis showed that the 
advantage of using capital in production is really 
an advantage of applying available factors of 
production in a longer-time rather than a shorter- 
time process. Since capital is a derivative factor, 
we may, bearing in mind that labor is applied to or 
in cooperation with land, say that the advantage 
of using capital is an advantage of applying 
labor so as to bring a relatively remote reward 
as compared with applying it so as to secure a 
relatively early reward. Greater roundaboutness 
of production may mean the lapse of a greater 
period of time between effort and the enjoyment 



The Causes of Interest. 109 

of its results or it may mean an increase of the 
proportionate amounts of effort and of land the 
use of which is directed to securing comparatively 
distant gains. 

It should be again emphasized, at this point, 
that capitalistic production is not always socially 
beneficial production and that capital is not always 
material technological equipment. The production 
of adulterated foods may be carried on capitalistic- 
ally. And not only well-deserved goodwill, but 
also public favor due to sedulously propagated 
misinformation and governmental encouragement 
due to selfish political activity or even to bribery, 
may constitute part of a concern's capital. The 
seeking of such favor or encouragement means 
engaging in roundabout production. Nevertheless, 
though capitalistic processes may be anti-social 
and the returns received may be therefore un- 
earned, it does not follow that such must be the 
case. In an ideal economic society, all such anti- 
social methods of wealth getting would be effect- 
ively prohibited and in such a society, therefore, 
no one could derive income from capital without so 
using it as to give a corresponding service to the 
community in return. 

That all possible kinds of capital, and, therefore, 
all possible roundabout productions, yield a surplus 
over direct production was not asserted. But there 
seem to be enough roundabout applications of labor 
which do yield, or at least promise, a surplus over 
direct production, to occupy more of our effort 
and attention than we are willing to devote to the 
securing of deferred rewards. Nevertheless, round- 
about production appears to yield less the farther 



110 Earned and Unearned Incomes. 

it is extended. There is, in this regard, a law of 
diminishing returns. To increase indefinitely the 
amount of labor and land devoted to capital 
production will not proportionately increase the 
gains from the use of capital. There comes to be 
a relative superfluity of capital. Nor, apparently, 
can the durability of capital instruments be in- 
definitely increased with indefinitely increasing 
advantage. 

To say that roundabout production involves wait- 
ing is equivalent to saying that capitalistic produc- 
tion involves saving. In roundabout production 
capital is an intermediate stage between effort and 
its rewards. The production of capital and like- 
wise its maintenance requires waiting or saving, 
requires a refraining from the present consumption 
which would otherwise be possible. The older 
economists spoke of this refraining as abstinence. 
Some modern economists speak of it as waiting. 
Others refer to time-preference or to impatience. 
Impatience or preference for present income over 
future income is not universal. The man whose 
present needs are fully supplied and who an- 
ticipates a needy future may definitely prefer 
future income to present. Even without prospect 
of surplus gain, many persons may eagerly save 
for old age or to provide funds for the support 
and education of their children who may become 
orphaned. But it is asserted that the sums saved 
would be less than they are were no surplus 
return securable by saving. The argument to this 
effect may not seem to everyone absolutely con- 
vincing. There may indeed be persons who would 
save more at a lower interest than at a higher. 



The Causes of Interest. Ill 

On the whole it seems probable that the lure of a 
return on accumulated wealth is a real influence 
in increasing the amount of such wealth and that 
saving would be much less, the amount of capital 
less and, therefore, the amount of roundabout 
production less, if saving and roundabout produc- 
tion did not pay. However this may be, it seems 
clear that roundabout production does yield a 
surplus, that the amount of saving men are will- 
ing to do has not been sufficient to reduce the 
marginal gain or surplus to zero and that interest 
is an important fact in modern business life. The 
way in which capital productivity and the indis- 
position to save indefinitely, work together to 
produce a rate of interest will be considered in 
the next chapter. 



CHAPTER IV. 

THE RATE OF INTEREST 

§ 1 
The Choices of a Crusoe 

Before considering in detail the working out of 
the forces determining interest in modern society, 
let us ask how these various forces would act upon 
an islanded Crusoe. The Crusoe of the story 
begins his isolation, not absolutely without capital, 
since something is saved from the wrecked ship, 
but with comparatively little capital. As he has 
leisure from the activities necessary for present 
support of life, he devotes himself to making 
equipment for his continued existence on the island. 
He builds himself a house, cuts a boat out of a 
log, makes himself bow and arrows, accumulates 
a herd of goats, and in other ways prepares him- 
self against the contingencies of the future. To 
do this, he has, of necessity, either to lay aside a 
store of food for use while producing equipment or 
to devote a part of his time each day or week, 
while producing the equipment, to the production 
of necessary food. In either case he may be said 
to use part of his labor for purposes other than 
the satisfaction of his immediate wants, to practice 
abstinence in not immediately consuming all that 
his labor produces, to save or accumulate the 
results of a part of his labor against the possibil- 
ities of future use. And in either case this saving 
takes, eventually, the form of buildings, tools, 
flocks and herds, orchards, etc. 

(112) 



The Rate of Interest 113 

In accumulating these various kinds of equip- 
ment, Crusoe uses a roundabout rather than a 
direct method of satisfying his later needs. He 
might get along by consuming such sea food as he 
could find, in various depressions and crannies, 
after the outflow of the tides. He chooses rather 
to deny himself some immediate satisfactions in 
order to make a net and fishing lines. He might 
plan to use the net and lines from the shore or by 
wading out in the water. Instead he prefers to 
sacrifice, in part, the early income thus securable, 
and to devote some of his time to building a boat. 
He might hunt all over the island for a goat to 
kill, whenever he was hungry for meat. He chooses, 
however, to make the sacrifice, early in his 
islanded life, either of consuming less I'leat or of 
spending more time in goat capture, so that, later, 
a minimum of labor may provide him with a 
maximum of meat. For a like reason he builds 
fences to keep his captured goats from escaping. 

In all this turning of labor to remote ends there 
is presumably some gain. But we may fairly 
assume the most important, the most advantageous 
capital to be constructed first. It is important to 
have a net, less important but still worth while 
to have a boat. Likewise, progressive improve- 
ments in the quality of the tools and buildings 
required, have progressively less and less im- 
portance. Crusoe must, therefore, decide at what 
point he no longer cares to make present sacrifices 
for the larger but larger-to-a-decreasing-degree, 
future gains. At the beginning, having little 
accumulated capital to work with, Crusoe has to 
devote much of his time to supplying present 



114 Earned and Unearned Incomes 

necessaries. He can devote little time to producing 
equipment, just because he has but little equip- 
ment to work with. For the same reason the 
time he is able to devote to producing equipment 
does not provide him with any large amount of 
it. But roundabout production is of the greater 
relative advantage to him so far as he can carry it 
on, just because he can afford to resort to it so 
little; and this large per cent gain may tempt him 
to forego present consumption almost as far as 
he possibly can do so. He practices abstinence, 
abstaining, so far as he can, from present con- 
sumption, for the sake of the gains to be realized 
by so doing. When he begins to realize these gains, 
to enjoy the larger production which his equip- 
ment makes possible, or to produce the old neces- 
sities in less time, he will be able to spare more time 
for the further elaboration of tools; but the per 
cent gain from so doing will be reduced. With 
his already accumulated tools, Crusoe's labor 
directed to providing immediate satisfactions is 
now much more effective than formerly. More or 
better tools might result in further gain but the 
gain becomes progressively smaller.^ 

But in all this, though we have influences of 
the kind which bear upon the rate of interest, we 
do not have a problem of interest such as exists 
in modern society. A Crusoe may, indeed, compare 

1 Probably the rational thing for Crusoe to do, if he expected no 
one to follow him, would be to wear out gradually, as life drew to a 
close, the accumulated equipment of early years; but if he could 
hope to be succeeded by descendants, or others in whose welfare he 
would feel deeply concerned, there would be reason in his keep- 
ing up his equipment to the last. 



The Rate of Interest 115 

present goods and future. He may determine 
that his home is the equivalent of a certain amount 
of food. He may give up certain enjoyments to 
secure it, thus showing that he regards it as 
preferable to those enjoyments. In a sense he values 
it in terms of the kind of enjoyments sacrificed. But 
there is lacking an alternative which exists in 
organized society as we know it and which has 
considerable significance, the alternative, that is, of 
devoting himself to producing either present or 
future goods and securing the other type of goods 
by exchange. He may produce the one type of 
goods or the other, and he may determine how 
much of the one type he will have and how much 
of the other and when it no longer seems worth 
while to devote an extra hour to the one purpose to 
the exclusion of the other purpose. But he cannot 
take advantage of his own specialized skill and 
that of another, to devote himself to one line of 
production and trade the results for the products 
of another line. There is not open to him, 
isolated as he is, the opportunity to make capital 
for the use of others who have not saved, when he 
has accumulated so much for his own use as to 
have little to gain from the production for his 
own use alone of more. In other words, he cannot 
devote himself entirely to production for the 
future, e. g. to making a boat, and expect to trade 
the results of his labor for present income, e. g. 
fish. Neither can he, if he would have any tools 
of production, devote himself entirely to producing 
consumable goods and trade these with anyone 
else for production goods. Could he do these 
things, the rate at which he would trade the one 



116 Earned and Unearned Incomes 

kind of goods for the other might well be in- 
fluenced by his alternative of himself producing 
the other. Thus, the rate at which he would ex- 
change consumable goods for capital might well be 
affected by the alternative of his producing that 
capital. There are, of course, points of similarity 
in the position of a Crusoe and a man who is 
part of an industrial society, but it seems never- 
theless necessary, fully to explain the phenomena 
of interest, to consider the rate of interest in the 
light of the various possible exchanges and alter- 
natives which have a bearing upon it. In particular, 
we shall examine the bearing, on the rate of in- 
terest, of the productivity of capital and of 
impatience or the indisposition to save. 

§ 2 

The Demand for Present Goods 

Indirect or roundabout production differs from 
direct production in that it requires waiting. 
Therefore the surplus of relatively roundabout 
production, at the margin beyond which it has not 
been carried, over what the same labor would yield 
if directly applied, we may term the marginal prod- 
uct of waiting. Thus, if a given amount of labor 
can yield an immediate product of 100 or can, by 
being stored in capital, yield a product one year 
later of 110, then the surplus product, 10, may be 
spoken of as the marginal product of "waiting." 
If we measure waiting by amount of gratification 
postponed and duration of postponement,^ we may 

2 Suggested by C Cassel, The Nature and Necessity of Interest, 
London (Macmillan) , 1903, p. 42. 



The Rate of Interest 117 

say that the marginal product of waiting is, in 
this case, 10 per cent. In practice, roundabout 
production involves the cooperation of later labor 
with the capital which earlier labor has produced. 
Hence when we suppose that labor turned to 
roundabout production will produce (say) 10 
per cent more than the same amount of labor 
turned to direct production, we do not mean that 
this year's labor, for example, will produce 
capital which, a year later, and without any co- 
operation of further labor with it, will yield a 
product 10 per cent larger than could have been 
produced directly. We mean, rather, that if the 
''center of gravity" in time, of the receiving of the 
product of the labor, is a year later than the 
time center of gravity of the putting forth of 
effort, the product will be 10 per cent larger than 
if it is received currently with the application of 
the labor. To illustrate, suppose that labor is 
put forth daily for three years but that for the 
first two years no consumable return is derived, 
the return being realized throughout the third 
year, during which the capital produced is operated 
and wears out. The time center of gravity of the 
labor would then be a year and a half from the 
beginning of the process and the time center of 
gravity of receiving the consumable return would 
be two years and a half from the beginning. The 
return may therefore be said to be received a 
year later than the labor is put forth.^ And if 

" See Bohm-Bawerk's explanation of an "average production 
period," The Positive Theory of Capital, English Translation, 



118 Earned and Unearned Incomes 

this return is 10 per cent larger than could have 
been secured by carrying on direct production and 
getting consumable goods currently throughout 
the three years, then the marginal product of wait- 
ing may be said to be 10 per cent. In the abstract 
discussion which is presented in this and the 
next few sections of this chapter, the expressions 
"this year's labor" and "present labor" may be 
understood to have reference to labor of which the 
time center of gravity is in the present, and ex- 
pressions relating to "present goods" or "next 
year's goods" may be also interpreted in terms of 
a time center of gravity. 

We have seen that roundabout production yields 
a surplus over direct production. By so doing it 
affects simultaneously the rate of interest and 
individual rates of impatience (rates of preference 
for present goods over future goods). We shall 
see, as we proceed, that it does not aifect the 
former primarily by first determining the latter. 
To show how greatly the productivity of waiting 
can influence interest, let us assume that indirect 
production could be indefinitely extended without 
reducing the reward of marginal waiting below 
10 per cent. Then the rate of interest could not 
be less than 10 per cent, nor could individual rates 
of impatience be less, and the marginal productiv- 
ity of waiting might be said, in so far, to deter- 
mine both. It determines interest by affecting 
both the demand and the supply sides of the 
market. It determines impatience by causing the 

London (Macmillan) , 1891, p. 89. Cf. Jevons, The Theory of Politi- 
cal Economy, fourth edition, London (Macmillan), 1911, pp. 227-229. 



The Rate of Interest 119 

adoption, to a considerable degree, of roundabout 
production, and therefore making present income 
relatively scarce and future income relatively 
abundant. Thus impatience is increased.* 

Putting the matter in terms of demand for and 
supply of present goods, we may say that if the 
indirect method would yield continuously, and 
even though indefinitely extended, a 10 per cent sur- 
plus, then a rate of exchange of less than 110 of 
next year's goods for 100 of this year's would 
mean a demand for present goods in excess of 
the supply. On the demand side, if the marginal 
product of waiting is equal to 10, the possibility of 
getting 100 of present goods for 105 of next year's 
goods, would mean a greater demand for the pres- 
ent goods than if the marginal product of waiting 
were but 5. For all those classes of persons, e. g., 
spendthrifts and necessitous persons such as labor- 
ers, who, in effect, habitually buy present goods 
with future, would have, with the higher assumed 
productivity of the roundabout methods at which 
they are engaged or to which they can turn, more 
future goods to offer for present. At a rate of 
exchange of 105 future for 100 present, they would, 
in producing 110 future and buying 100 present, 
have 5 of future, i. e., next year's goods, left over 
with which to demand more present goods; where- 
as if roundabout production were only 5 per cent 
superior, this surplus demand for present goods 
could not exist. Thus, with a marginal pro- 
ductivity of waiting equal always to 10 per cent, 

* See Bohm-Bawerk, Positi've Theorie des Kapitales, Dritte 
Auflage, (Innsbruck), 1912, p. 468. Cf. Fisher, The Rate of In- 
terest, New York (Macmillan) , 1907, pp. 186, 187. 



120 Earned and Unearned Incomes 

necessitous wage earners, if they received 100 of 
present goods for every 105 of next year's goods 
produced by their work, might be said to demand 
more present goods than if the marginal productiv- 
ity of waiting were only 5 per cent. For in the 
former case they still have a future product of 
5, after getting 100 in present goods, for which 
surplus 5 they demand a further quantity of this 
year's goods. We may therefore assert that the 
higher is the marginal product of waiting and the 
more slowly this marginal product declines with 
increased quantity of w^aiting, the greater will be 
the demand, at any given price or value in future 
goods, for present goods. This is a use of the term 
^'demand" analogous to its use in the theory of 
price and value. Unfortunately, economists are 
apt, in such discussions as the present, to use the 
terms ''supply" and "demand" loosely and without 
careful analysis. 

It should be observed that this greater demand 
for present goods, at a rate of 105 of next year's 
goods for 100 now, due to the 10 per cent supe- 
riority of indirect production, is not, necessarily, 
brought about through any effect on impatience. 
The greater demand for present goods at any rate 
of interest less than 10 per cent may be due direct- 
ly to this superior productiveness of the capitalistic 
method, or, if we use Bohm-Bawerk's phrase, to 
the technical superiority of present goods. Let us 
suppose, for illustration, a man who must have 100 
this year in order to maintain life. He does not 
possess it and if he cannot borrow it, will have to 
produce it. But if he can borrow it he will then 
be in a position to turn his attention towards 



The Rate of Interest 121 

roundabout production, which, otherwise, he could 
not possibly do; and he will therefore be able to 
produce 110 a year later with the same labor re- 
quired to produce 100 this year. Will he not, if 
interest is 5 per cent (or anything less than 10) be 
very glad to get 100 of present goods and so be 
able to produce 110 a year later? Yet this will not 
of necessity be due to his impatience. He may be 
a man who, were any other way possible of getting 
the 110 next year, would refuse to borrow 100 even 
at only one per cent interest. He may have so 
little impatience that even an income stream rising 
at such a rate as 10 per cent, would not induce 
him to seek present goods for future. He may 
have a zero rate of impatience, if not a negative 
one. If he borrows 100 for this year's use, in 
order that he may work hard at roundabout pro- 
duction when otherwise he would do an equal 
amount of work in securing 100 in this year's 
goods, it certainly cannot be said that he borrows 
in order to provide for present needs out of future 
abundance, for his present needs are no better pro- 
vided for than if he did not borrow. He works 
just as hard and has this year no greater income. 
The fact is that such a man does not borrow be- 
cause he is impatient and wants more present in- 
come at the expense of his future. In borrowing, 
he really is not comparing this year's 100 with 
next year's repayment of 105, for he could get this 
year's 100 for the work he is in any case doing. 
He is comparing the 110 which roundabout pro- 
duction will yield him next year, with the 105 of 
next year's goods (or anything less than 110) 
which he must pay for the 110. He is comparing 



122 Earned and Unearned Incomes 

two futures, rathe?' than a present and a future.^ 
He is going to have 100 this year whether he bor- 
rows or not. He is going to do a given amount of 
productive work this year whether he borrows or 
not. If he borrows he simply makes the difference 
between 110 and what he has to pay next year for 
the loan. In what possible sense can it be said 
that he borrows only because he is impatient? 

Here we may note an error in Fisher's criticism 
of Bohm-Bawerk, though one which appears to lurk 
in the latter's own presentation of his theory. Pro- 
fessor Bohm-Bawerk in his Positive Theory of Capi- 
tal^ has a series of tables illustrating the technical 
superiority of present goods, the point being that 
early goods are to be preferred to later because 
they make possible more roundabout production, 
e, g.f to use the figures of this article, that 100 
this year is preferable to 100 next year, because 100 
this year makes possible 110 next year, through the 
adoption of roundabout processes. Fisher's argu- 
ment is, in effect,^ that 100 now would be no better 
than 100 next year, if man were not impatient, 
because 100 next year would make possible 110 year 
after next; that as much would be enjoyed even- 
tually, and so if one did not mind waiting, either 
option would be as good as the other. Professor 
Fisher's statement^ is that "the only reason any- 

5 Cf. Bohm-Bawerk, Positive Theorie des Kapitales, Dritte 
Auflage 1912, (Exkurse), pp. 406-409. 

6 The Positive Theory of Capital, English Translation, London 
(Macmillan), 1891, pp. 362-269; Dritte Auflage, 456,466. 

'^ The Rate of Interest, pp. 58-71. 
^ Ibid., pp. 70, 71. 



The Rate of Interest 123 

one can prefer the product of a month's labor in- 
vested today to the product of a month's labor in- 
vested next year is that today's investment will 
mature earlier than next year's investment." In 
view of what has been said in the foregoing pages, 
it seems to the present writer that this criticism 
really fails to meet the essential point of the argu- 
ment. So long as 100 this year makes possible 110 
next year, many persons will be very anxious to get 
the 100 provided they do not have to pay back 
quite all of the 110. Their total income will be 
larger and not m_erely earlier because of such a 
choice. A proper comparison of the two options 
begins ivith the present in both cases, not, as Pro- 
fessor Fisher would have us believe, a year later 
in one case than in the other. In either case, in- 
come and work would begin with this year. In the 
one case the loan of 100 would make possible begin- 
ning the more productive indirect method at once. 
In the other case the first year would have to be 
spent in the use of the less productive direct 
method. All question of impatience aside, the first 
choice would be preferable to the second since it 
would yield during any given period, a greater total 
result.^ Nevertheless it must be admitted that 
Bohm-Bawerk's tables do not all consistently ex- 
press this view.i^ 

9 See Bohm-Bawerk, The Positive Theory of Capital, English 
Translation, p. 271 ; Dritte Auflage, p- 469. See also Exkurse XII, 
in answer to Fisher's criticisms. 

'^^ Thus, in the tables beginning on page 266 (English transla- 
tion), Bohm-Bawerk selects for comparison the maximum value in- 
comes derivable from earlier and later labor even though this 
means comparison of an income received in 1890 from labor availa- 



124 Earned and Unearned Incomes. 

Professor Fisher, in attempting to show that 
all loans are really made to provide present income 
for those who desire the loans, even if they are so- 
called productive loans, assumes the case of a 
business man who borrows to make an investment 
and who has the three options of not investing, 
and of making the investment by sacrificing part 
of his early income for the sake of later or by bor- 
rowing so as not to have to sacrifice early income.^^ 
But in our example above described, the borrower 
has but the first and third of these options. If he 
cannot borrow, he cannot invest, that is, he cannot 
choose roundabout production. It cannot be said, 
therefore, that he borrows to supply present needs, 
and it cannot be said that borrowing, in general, 
is necessarily a means of providing the present at 
the expense of the future, but that there really are, 
contrary to the viewpoint of Fisher,!^ productive 
loans in the sense in which economists have used 
that expression. Impatience is only one cause, 
and perhaps a minor cause, of the demand for 
present goods. 

In concluding, now, our analysis of the demand 
side of the market in so far as it shows a tendency 
of productivity of waiting to keep interest up, may 
we not state a quantitative result? Assuming that 
the marginal productivity of waiting, however far 
extended, is 10 per cent, and that the supply of 

ble in 1888 with an income received in 1893 from labor available 
in 1889. 

1^ The Rate of Interest, pp. 246-251. 

12 Ibid., p. 251. 



The Rate of Interest. 125 

present or early goods is not unlimited, may we not 
assert that at a rate of interest appreciably less 
than 10 per cent, the demand for present goods or 
relatively early goods, must exceed the supply? 
For even those who are not by nature so impatient 
as to purchase present goods for future at that 
rate will nevertheless purchase present or compar- 
atively early goods, that they may extend the 
amount or the time of indirect production and 
reap a gain in so doing.^^ 

§ 3 

The Supply of Present Goods Offered for Future 

Goods 

On the other hand, a high marginal productivity 
of capital or of waiting tends to decrease the supply 
of present goods, at any given price in terms of 
future goods. Thus, with the marginal productivity 
of indirect production 110, however far extended, 
as against 100 for direct, nobody would supply 

13 The contention is sometimes made by productivity theorists 
that increased productiveness of capital must be assumed to raise the 
rate of interest because value is relative and all values cannot go 
down (Seager, The Impatience Theory of Interest, American 
Economic Review, December, 1912, pp. 834 and 835). Even though 
the supposition be made, for greater clearness of exposition, that the 
quantity of money and credit keeps such a relation to goods as to 
maintain an unchanging general price level, such an argument is 
hardly sufficient. For the impatience theorist might still argue that 
the value of capital would go up and the value of consumable goods 
down because of the increased capital productiveness, and that in- 
terest would not rise. Some such argument as is presented in this 
chapter is believed, therefore, to be essential if the problem is to 
be anything like completely analyzed. 



126 Earned and Unearned Incomes. 

present goods at all if offered a price of only 105 in 
next year's goods for 100 present. If roundabout 
production yielded less, say 4 or 5 per cent, such an 
offer might bring out a supply of present goods. 
But with roundabout production yielding a 10 per 
cent yearly surplus, it would not be worth while 
for any one to produce present goods at all in order 
to make such an exchange. Rather than produce 
present goods to the amount of 100 and exchange 
or sell them for 105 of next year's goods, any 
producer would prefer to get, by the indirect 
method, 110 of next year's goods. We may put 
the matter in a somewhat different way if we first 
call attention to the fact that wages are paid, in 
the first instance, neither in present consumption 
goods nor yet in future goods (durable capital) 
but in general purchasing power. The amount that 
an employer has to pay in wages will, presumably, 
be the same whether he employs his men in direct 
or indirect production, in producing present or 
future goods. But if employing them in indirect 
production will yield 110, no employer is going to 
pay the same wages for present goods of 100, and 
then supply these goods for the equivalent of 105 
in the goods of a year later. An employer will 
either receive for his 100 a purchasing power over 
110 of next year's goods, or he will have next 
year's goods produced instead of present goods. It 
appears, therefore, that if indirect production can 
be indefinitely extended with a surplus return of 
10 per cent, any appreciably less rate of interest 
than 10 per cent would certainly mean a supply 
of present goods less than the demand. Therefore 



The Rate of Interest. 127 

a rate of appreciably less than 10 per cent could 
not continue. 

It is worth while calling attention again at this 
point to the fact that we are dealing here with an 
independent cause of interest other than impatience. 
It is not, in our example, because those on the 
supply side of the market are impatient, that they 
will not dispose of 100 present goods for less 
than 110 of next year's goods. It is rather because 
nature or invention or, more properly, both, gives 
them the option of getting the 110 next year, 
through their own present efforts, if they will, 
instead of by lending or selling present goods for 
future. Is a man impatient because he will not 
accept 105 of next year's goods when he may, by 
the same present effort, get 110? The choice is 
between a smaller future income and a larger, not 
between a present and a future income. How, 
therefore, can impatience be said to be involved as 
the cause? Impatience or time preference is a 
state of mind relating to present compared with 
future goods; not related to future compared 
with other future goods. 

The above argument shows, it is believed, that 
productivity of capital has both a direct and a 
proportionate effect upon the rate of interest, if by 
productivity we here mean surplus productivity 
over direct production. To double the surplus 
productivity of any one instrument of capital would 
not, of course, appreciably affect the rate of 
interest, because it would mean but a slight 
change in the market conditions of supply and 
demand. The increased supply of products or 
uses would, if the capital were itself produced by 



128 Earned and Unearned Incomes. 

labor, merely lower their price in relation to other 
goods. But permanently to double the surplus 
productivity of capital in general, in other words 
to double the marginal product of waiting and 
to keep this marginal product, however great the 
increase of waiting, double what it has been, would, 
and must, not less than double the rate of interest. 
For if the surplus marginal productivity of capital 
were changed from 10 to 20 per cent, no one 
would any longer, however low his impatience, 
consent to lend or invest present goods for 10 per 
cent. Rather would he adopt indirect production 
and realize 20. His refusal to accept 10 would not 
be due, necessarily, to his impatience but directly 
to the fact that he has now a better option than 
before. The assertion that^* "to raise the rate of 
interest by raising the productivity of capital is, 
therefore, like trying to raise one's self by one's 
own boot-straps," hardly gives a true account of 
the situation even though only a direct and not an 
indirect effect is denied. Neither is it convincing 
to state that^^ "an increase of the productivity of 
capital would probably result in a decrease instead 
of an increase, of the rate of interest," and that "to 
double the productivity of capital might more than 
double the value of the capital," unless by 
productivity is meant productivity in general and 
not merely the surplus productivity of indirect 

1* Fisher, The Rate of Interest, p. 15- 

15 Fisher, The Rate of Interest, p. 16. But it is only fair to state 
that Professor Fisher's elaborated theory gives considerable empha- 
sis to productivity as an indirect cause working through impatience. 



The Rate of Interest. 129 

production. As a matter of fact to double the 
surplus" marginal product from 10 to 20 and keep 
it so, would very decidedly not double the value of 
capital. For no one, however low his impatience, 
would be willing to give more than 100 in present 
goods for 120 of next year's goods when the labor 
necessary to produce the present 100 would be 
sufficient to produce the deferred 120. It is true 
that such an increase of productivity as we have 
assumed might, when it had greatly increased 
wealth, tend to reduce impatience and therefore, 
eventually, to make possible an extension of in- 
direct production to where the marginal product of 
waiting was a smaller amount than before. But 
unless and until it did this, the greater productivity 
could not possibly result in a decrease of the rate 
of interest. And it is certainly not true as 
Professor Fetter would have us believe, that a 
theory which asserts productivity to be an in- 
dependent, direct cause and determinant of interest 
must assume a rate of interest in its premises and 
so involves a begging of the question." It starts 
with a rate of interest only in the sense that it 
starts with a rate of productivity which in large 
part determines the rate of interest. Even the 
productivity theorist who asserts, flatly, that 
interest will be 20 per cent if a capital of 100 

16 If the surplus marginal product Is lo, the total marginal 
product of capital is no. To double this would make it 220, in- 
creasing the surplus marginal product, or the marginal product of 
waiting, to 120- 

^'^ See, for example, Professor Fetter's critical article, Interest 
Theories, Old and New, in the American Economic Review, March, 
1914, especially page 90, 



130 Earned and Unearned Incomes 

produces on the average, at the end of a year, an 
income of 120, though his analysis may be incom- 
plete, is not, perhaps, fundamentally in error. For 
it is not necessarily true that a person values his 
capital at 100 only because, having an impatience of 
20 per cent, he discounts the expected income at a 
20 per cent rate. On the contrary, he values his 
capital at 100 because the amount of labor neces- 
sary to produce it, i. e., necessary to get a final 
result a year later, of 120, is just equal to the 
amount of labor necessary to get 100 right away. 
He does not value the capital at more than that, i. e., 
will not give more than that for it, because he 
has the option of always being able to get it at 
that price or value in terms of labor. The sum 
100 may properly be called its cost of production. 
In this sense it is fair to say that interest is 20 
per cent if and because a capital of 100 will produce 
income at the end of a year, of 120, or will produce 
20 a year. We may say that a person's valuation of 
capital, along with the valuations of other persons 
in like situation, is less the direct result of a 
previously existing market rate of interest, than it 
is, by affecting his and their attitude towards the 
market, a determinant of the rate of interest. 

We are prepared, now, to see more clearly than 
before the importance of the distinction between 
land and made capital. Land is already present. 
For the most part there is no balancing of choice 
as to whether or not we shall produce it. Its value 
depends upon its expected future benefits and the 
rate of interest or impatience at which they are 
discounted. But there is the option, during any 
period, of producing more or less of other capital, 



The Rate of Interest 131 

turning towards or away from roundabout pro- 
duction. The value of this other capital is just 
as much dependent upon its cost of production, in 
the sense above explained, as upon any indepen- 
dently existing rate or rates of impatience. The 
possibility of getting a larger product of labor, a 
surplus over the reward of direct production, by 
applying that labor indirectly, with, as an interme- 
diate step, the use of "produced means to further 
production,"^^ will tend to prevent enterprisers and 
others from accepting any less surplus as interest on 
loans or on purchase of goods already produced. 
This possibility will therefore, in so far, tend to fix 
the rate of interest and of discount. 

Does impatience then enter nowhere into the 
chain of cause and affect? It does enter, but, in 
the connection to be now emphasized, as effect 
rather than cause. The marginal productivity of 
waiting, if 10 per cent regardless of extension, will 
directly influence supply of and demand for present 
goods in such a way that, at any lower interest 
rate than 10 per cent, supply will fall short of 
demand. It is also true that a marginal produc- 
tivity of waiting, of 10 per cent, will cause rates 
of impatience to be correspondingly high. The 
supply of and demand for present goods, and hence 
the rate of interest, is one chain of effects follow- 
ing from the marginal productivity of waiting. 
The comparative deprivation of the present and 
endowment of the future and the consequent high 
rate of impatience, constitute another chain of 

1* Phrase used by Seager, The Impatience Theory of Interest, 
American Economic Review, December, 1912, p. 846. 



132 Earned and Unearned Incomes 

effects. We are here dealing with common effects 
of a joint cause, not with a single chain of 
causation. 

§ 4 

Demand for and Supply of Present Goods Further 

Considered 

On the other hand, still assuming a marginal 
product of waiting equal to 10 per cent, and assum- 
ing now that it does not become greater than that 
even with indefinite decrease of roundabout pro- 
duction; then at a higher rate of interest than 10 
per cent, we should expect to find demand for 
present goods less than supply. If the rate of 
interest were 15 per cent, that is if the price of 
present goods in terms of future were 115, compara- 
tively few persons would be willing to buy present 
goods. Why offer 115 of next year's goods for 100 
of this year's when 100 of this year's can be pro- 
duced by the direct method in the same time that 
it takes to produce only 110 of next year's. There 
might be persons of spendthrift habits and no 
trustworthiness who would be willing to promise 
almost any price in future goods in order to get 
100 in present goods. But such persons could 
not be relied on to pay the price and, therefore, are 
not really in the market. They have a desire 
rather than a demand. There might be a real 
demand for present goods at a 15 per cent rate 
from persons of spendthrift proclivities who, by 
past accumulations or by inheritance of capital, 
possessed the means to pay. But such persons 
would soon eliminate themselves as factors in the 



The Rate of Interest. 133 

problem, and even while they were in the market, 
conditions of supply would keep interest down to 
about 10 per cent. The great mass of consumers 
would not be in a position to give, as a rule, more 
than 10 per cent. Most of them are wage earners 
and in many cases they have little security to 
offer. They buy present goods, in effect, with the 
future goods their labor produces. That is their 
chief and in many cases their only means of pur- 
chase. If the same labor which produces 110 of 
next year's goods by the indirect method, would 
produce directly 100 of this year's, they would 
not bid for the 100, an amount equal to 115 of the 
goods available a year later. Rather than do this, 
they would seek employment producing directly this 
year's goods and so avoid the 15 per cent interest. 
Looking at the matter from the supply side, we 
may say that a rate of interest of 15 per cent when 
the marginal product of waiting is 10 per cent, 
would almost certainly result in a supply of 
present goods in excess of the demand. For no one 
would produce 110 of next year's goods, however 
little impatient he might be, so long as he could 
produce with the same labor, 100 of present goods 
and sell them for 115 of next year's. No one 
would hire labor to produce 110 of next year's 
goods when for the same wages he could hire 
them to produce 100 of this year's and could sell 
this 100 for 115 of next year's. In short, at a rate 
of interest of 15 per cent, the supply of present 
goods would exceed the demand, by the turning of 
quantities of labor from indirect to direct produc- 
tion, until the large amount of early income and the 
scarcity of future income, lowered interest and 



134 Earned and Unearned Incomes. 

impatience to 10 per cent. The influence of supply 
would keep interest as low as 10 per cfnt for all 
those able to give security and therefore really 
in the market, unless mankind were so little thrifty 
that no amount of turning production to the direct 
method, no possible stocking of the present and 
deprivation of the future, could keep their impa- 
tience down to 10 per cent, the assumed produc- 
tivity of waiting. In such a world or such a 
community, there soon would be no indirect or 
capitalistic production, but a mere living from 
hand to mouth; and there could be no loans except 
the so-called unproductive loans. 

We may conclude, therefore, that by acting on 
the supply of present goods and the demand for 
them, the superiority of roundabout production 
tends to keep interest down to as well as up to 
the marginal productivity of waiting. Interest 
to those really in the market (because able to give 
security), cannot go above this per cent so long 
as a community is thrifty enough to use any degree 
of indirect production, and is therefore able to 
increase present goods and decrease future by turn- 
ing more largely toward direct production. And 
it cannot go below this, so long as a community 
has still not reached an impassible limit of in- 
direct production but is yet able to turn more labor 
toward indirect production or to make the method 
of production still more roundabout, — to increase 
either the amount or the time, of waiting. 

Assuming, therefore, a constant marginal produc- 
tivity of waiting, equal to 10 per cent, and a rate 
of impatience affected by the shape of the income 
stream^ this rate of impatience, as well as the 



The Rate of Interest. 135 

rate of interest, will adjust itself to the rate of 
productivity of waiting. On the other iiand, were 
we to assume a constant natural rate of impatience 
regardless of changes in the income stream, and at 
the same time a productivity of waiting decreas- 
ing with the extension of indirect production, then 
the marginal productivity and the rate of interest 
would adjust themselves to the impatience. In 
practice, doubtless adjustment takes place both in 
marginal productivity of waiting and in impatience, 
but the influence of productivity has, it is believed, 
an importance which we are not likely to over- 
emphasize. 

In a modern community production is capitalistic 
to a great degree. It would be possible to make it 
capitalistic to an indefinitely greater degree with 
continuing gain in productiveness. We are little 
interested in the theory of how interest might be 
fixed in a community where the general rate of 
impatience is too high to permit any accumulation 
at all, or in a world where further extension of 
indirect production is impossible. In our existing 
civilization, the fact that capitalistic production 
could be much further extended, with, for a long 
time at least, a surplus gain, is of tremendous 
importance. It means that no amount of accumula- 
tion can be expected to reduce the rate of interest 
to zero.^^ It means that the marginal product of 
waiting is one of the most important factors in 
fixing the rate of interest, worthy of the emphasis 
which the marginal productivity theorists have 

1^ Cassel, The Nature and Necessity of Interest, London (Mac- 
raillan), 1903, pp. 156, 157. 



136 Earned and Unearned Incomes 

given to it, and that any theory which does not 
give large emphasis to this determining influence 
acting simultaneously on impatience and interest is 
either inadequate or misleading or both. It means 
that if the productivity of waiting were a given 
per cent regardless of an indefinite substraction 
from or addition to the supply of waiting, then that 
productivity would, in a modern civilized com- 
munity, fix both interest and impatience at its own 
exact per cent. It means, in short, that impatience 
is not the fundamental cause of modern interest 
nor even a cause through which all other causes 
must operate, but that it is one of two coordinate 
causes and is also to some extent a joint conse- 
quence, with interest, of the other cause, the 
superiority of indirect production. 

It may be worth while again to emphasize the 
importance of a correct use in this connection of 
the terms "supply" and ''demand." Marginal pro- 
ductivity is not to be looked upon as having to do 
chiefly with demand nor is impatience to be re- 
garded merely as putting a limitation on supply.^^ 
Neither is it correct to regard productivity merely 
as an explanation of why interest can be paid and 
impatience as a reason why it must be.^^ As we 
have seen, the marginal productivity of waiting 
determines the supply of present goods, in the 
proper sense of ''supply," quite as much as it 

20 This appears to be the view of Carver, expressed in The Dis- 
tribution of Wealth, New York (Macmillan), 1904, p. 224, and of 
Cassel {The Nature and Necessity of Interest, pp. 37, 45, 49). 

21 This seems to be the mode of treatment adopted in Ely, Outlines 
of Economics, New York (Macmillan), 1908, pp. 418, 419. 



The Rate of Interest 137 

determines the demand; and impatience, so far as it 
operates as an independent cause, affects the 
demand of those who desire present goods as well 
as the supply offered by those willing to take 
future goods. 

§ 5 

A Concrete Illustration 

To picture concretely the determination of a 
rate of interest, we may betake ourselves to Cru- 
soe's island after the addition to the island's 
population of the group of Spaniards. The un- 
improved land is valueless. It is all ''marginal" or 
"no-rent" land. One acre is as good as another and 
the supply is more than ample for all who live on 
the island. 

But on part of the land, Crusoe has made valu- 
able improvements. Among other things there are 
some trees of a certain sort, which yield nutritious 
fruit once, a year after being planted, and then 
die.22 On an average there are 110 of the fruit to 
a tree. Young trees, suitable for planting, grow 
on a neighboring island, as does also the fruit. 
This other island is not a suitable place for a 
permanent habitation. But it can be availed of 
for its products, and can be reached from Crusoe's 
island, except at high tide, by fording. At first, 
Crusoe went to the neighboring island, at picking 

22 This assumption is made only for simplicity. It is apparent 
that the principles involved would be no different on the supposition 
of (say) a thirty-year life and a yield each year after the tenth. 
But so complicated an illustration of the principle would make the 
argument more difficult to follow. 



138 Earned and Unearned Incomes 

time, for the fruit of these trees. But he soon 
found that it took him 10 trips to bring over, with 
considerable effort, 1,000 of the fruit, because of 
his limited carrying capacity; while 10 trips or, all 
things considered, an amount of labor equivalent 
to that required to bring 1,000 of the fruit, would 
enable him to bring over and plant 10 young trees. 
The next year these would yield, altogether, 1,100 
of the fruit. Conditions of moisture, fertility, etc., 
are such that the trees have to get their start, 
as seedlings, on the neighboring island. Hence a 
new supply has to be secured each year. But, 
though it involves a year of waiting, the same 
amount of labor yields Crusoe 10 per cent more by 
this roundabout method than by the direct. 

Enter now one of the Spaniards. Crusoe has 
just planted his year's crop of 10 trees. The 
Spaniard, who, in order to accumulate some capital 
of his own, is doing more work than is necessary to 
satisfy his present needs, would like to buy. Crusoe 
demands payment in terms of the kind of fruit the 
trees yield. One year hence the trees will yield 
1,100 of the fruit without appreciable further labor. 
How much of the fruit are they now worth ? How 
much will the Spaniard give? How little will 
Crusoe take? Is the question solely one of time- 
preference with each, or is something else involved 
in this valuation of capital? 

We may begin with the Spaniard. His position 
is analogous to that of a lender. If he buys the 
trees, he will be giving up present fruit for future 
fruit. What is the most he will give? He will 
be guided in his decision by two considerations. 
One of these is his impatience or time-preference. 



The Rate of iNXEiiEsf 1^^ 

The other is the cost-of-production (in the place 
desired) of the trees. If he dislikes to sacrifice 
present goods for future unless he gets a return 
of (say) 5 per cent, he certainly will not give 
1,100 of the fruit now for 1,100 a year from now. 
Even after he has gathered enough fruit, from 
the neighboring island, to buy the trees, he will 
refuse to buy them at any price above 1,048, and 
this refusal may be due to his time-preference. 
But will he give 1,048 if and because his impa- 
tience is only 5 per cent? By no means. For he 
has to deal with the fact that the same number 
of trips to the neighboring island and the same 
amount of labor, which will yield him 1,000 pieces 
of fruit, would get him 10 trees and plant them. 
If he has to pay Crusoe 1,048 pieces of fruit, he 
must work harder and make more trips, to get the 
means of buying the trees from Crusoe, than to get 
trees directly. He, therefore, however low his 
rate of time-preference, will refuse to pay more 
than 1,000 fruit for 10 trees, so long as he can get 
and plant 10 trees for himself with the same labor 
as is required to get the 1,000 fruit. His refusal to 
give more than 1,000 is not due to high time- 
preference for present goods but to his desire to 
get future goods in the cheapest way possible. It 
is not time-preference at all, but a choice between 
two different amounts of present labor, yielding the 
same future result. This is the sense in which the 
value of capital depends upon cost-of-production. 
The value of the trees cannot go above that amount 
of other goods which requires the same labor to get 
directly, as the trees do. The goods which could 
be got directly with the same labor and which must 



140 Earned and Unearned Incomes 

be sacrificed for the present if the trees are directly 
got instead, may be regarded, in an entirely 
proper sense, as the cost-of -"production of the trees. 
The essential fact is, then, that the prospective 
purchaser of capital has a choice among not less 
than three lines of action and not between two 
only. He is not, as the time-preference theorist 
would have us believe, restricted to a choice between 
the present fruit and the future fruit. Instead, he 
can have the present {%. e., the early or this 
year's) fruit, or he can have next year's fruit from 
the purchased trees, or he can have next year's 
fruit from trees which his own labor procures. 
Not only the preference for present (or early) con- 
sumption will cause him to refuse to pay a too 
high price for Crusoe's trees; but also his other 
alternative of producing (in the economic sense of 
producing — in this illustration, place utilities) 
the trees by his own labor, will cause him to 
refuse to pay a too high price in the other possible 
products of such labor. 

We reach a parallel conclusion if we suppose that 
the Spaniard, instead of buying trees of Crusoe the 
capitalist, employs Crusoe as a laborer to get the 
trees, paying him in present fruit. The Spaniard 
will not be willing to pay Crusoe more than 1,000 
fruit for the labor of getting or planting 10 trees. 
Rather than pay wages appreciably higher, he 
would himself get and plant the trees desired. To 
be an employer of labor, advancing present con- 
sumable goods for durable capital, he must produce 
present goods in excess of his own present needs. 
But he has the alternative of devoting his surplus 
time, instead, to the production of durable capital 



The Rate of Interest 141 

which will serve his future needs. This possible 
alternative will make him unwilling, however low 
his time-preference, to accumulate present goods 
for the payment of wages, unless his future return 
from so doing is equally large. 

Likewise, if we suppose him to lend to Crusoe, 
the rate at which he will lend is influenced directly 
by his other alternative, and not merely by his 
time-preference or by his other alternative acting 
through the intermediation of time-preference. He 
will not lend Crusoe 1,000 fruit this year for much 
less than 1,100 next year, however low may be his 
time-preference, because the labor necessary to 
secure him the surplus 1,000 this year above 
present needs will, if turned to more roundabout 
production, yield him a return next year of 1,100. 
He would rather get 1,100 next year as a result 
of this year's labor in roundabout production, than 
to get less than 1,100 next year as a result of this 
year's labor in supplying Crusoe's present needs. 
There is no intention to deny that the surplus 
productivity of roundabout production also 
influences time-preference, by influencing the rela- 
tive endowments of present and future.^^ Neither 
is there any intention to deny that the rate of 
time-preference, by influencing the extent to which 
roundabout production is carried, affects the 
marginal gain from such production. The rate of 
interest fixed by market competition will also be 
the rate of time-preference and the rate of surplus 
productivity of roundabout production. But to 

23 See Bohm-Bawerk, Positive Theorie des Kapitales, Dritte 
Auflage (Innsbruck, 1912), p. 468. 



142 Earned and Unearned Incomes. 

assert this is not to assert that time-preference 
is the sole proximate cause and that all other 
causes must act through it. As we have just seen, 
the rate of productivity influences directly the 
supplier of present goods; and the cost-of -produc- 
tion of capital, in the sense here used, has a 
direct influence on the demander of such capital. 
Suppose, nov^, v^e turn to Crusoe's side of the 
market, the side of the person who purchases 
present goods with future. What determines the 
price at which Crusoe will dispose of his 10 trees, 
or rather, since this is the important question in 
the long run for capital valuation, at what price 
in present fruit will Crusoe be willing to engage in 
the business of getting, planting, and selling trees? 
Crusoe, we may suppose, is now permanently on the 
present goods side of the market. He is no longer 
accumulating capital and has, perhaps, lost or 
dissipated what he had. If he produces durable 
capital, it is only to dispose of it for present con- 
sumable goods. Let it be understood that we are 
not assuming Crusoe to be a middleman. On the 
contrary, he is here the ''ultimate consumer." But 
he is also a producer. He wants present goods, 
present fruit. To get this fruit, he must either go 
to the neighboring island and bring it over or he 
must buy it of somebody else by offering future 
goods. Once he has produced these future goods, 
i. e., secured and planted the 10 trees, time-prefer- 
ence may alone decide at what rate he will exchange 
them for present fruit. But before he turns his 
labor in that direction, he will consider whether he 
can get more present fruit by producing durable 
capital to buy it with or by devoting the same 



The Rate of Interest. 143 

labor to getting the present fruit. Year in and 
year out Crusoe will not maintain the supply of 
more durable capital, i. e., will not produce it for 
sale, except at a price which is as satisfactory to 
him as the yield of direct production of present 
goods. The labor necessary to get the 10 trees is 
the same, on our hypothesis, as the labor necessary 
to get 1,000 pieces of the fruit. The 10 trees, 
planted near by, yield next year 1,100 pieces of 
fruit. 

Crusoe's rate of time-preference of course fixes 
a minimum below which he will not sell the trees. 
If his rate of time preference is 15 per cent, he will 
not sell them for less than 956 fruit, because he 
would rather wait for the 1,100 future fruit. But, 
in the long run, his minimum price is fixed by two 
considerations and not by one only. The second 
consideration is his alternative of directly producing 
the fruit by going to the neighboring island after 
it. Year in and year out, he will not bring, plant, 
and sell the trees for less than 1,000 of the fruit. 
If he cannot secure approximately that price for 
the trees, he will get the fruit directly instead of 
trading for it. The possibility of his doing so 
will itself tend to keep the trees scarce enough to 
yield that price in terms of the fruit. In other 
words, he will not sell the trees for less than their 
cost-of-production measured by the other goods 
which the same work would produce. 

Our conclusion is no different if we assume him 
to sell his services as a laborer, for wages, instead 
of selling the trees. He will not work for the 
Spaniard at the job of getting and planting trees, 
for a less wage in present fruit than the amount 



144 Earned and Unearned Incomes. 

of present fruit which the same labor would give 
him if applied directly to bringing the fruit from 
the other island. 

But instead of selling trees for present fruit or 
working for wages in present fruit, Crusoe may 
borrow present fruit to pay it back next year. 
Here, also, if he is a productive borrower, he is 
not simply comparing present and future benefits. 
If he has no accumulations and if, also, it re- 
quires all his present labor to provide for his 
present needs, Crusoe must needs engage in direct 
production unless he can borrow. If he can 
borrow 1,000 present fruit, he is relieved from the 
necessity of getting fruit now for present needs 
and can get the trees instead. But more than 
1,100 fruit next year for 1,000 fruit this year, he 
will not give, since the former represents more 
present labor than the latter. Only an unproductive 
borrower would make such a contract and he would 
soon be eliminated from the market. On the other 
hand, however low might be his time-preference, 
Crusoe would still be willing to borrow at any rate 
of interest less than 10 per cent. To do so would 
leave him as well off in the present and better off 
in the future. He would borrow at less than 10 per 
cent because to do so would give him a larger 
future income than not to do so. His comparison 
would be between two futures, rather than between 
a present and a future. 

Let us now turn again to the distinction between 
land and capital. The distinction is not, strictly, 
one between land and all other capital. It is a 
distinction rather between reproducible and non- 
reproducible goods. The paintings of old masters 



The Rate of Interest. 145 

and business sites in New York City are in the 
same category. For all practical purposes, they 
cannot be reproduced. It is not intended to argue 
that there is no "made land" or that land owes 
none of its value to work upon it. But so far as 
its characteristics cannot be reproduced, the value 
of land is not limited by its cost-of-production. 
Crusoe could not sell his 10 trees for more than 
1,000 pieces of fruit, for that was their equivalent 
of their cost-of-production. But if the island were 
crowded, and there were no practical possibility of 
adding to the land, no such definite limit would 
determine a minimum price of the land in terms 
of other goods. The value of this land could be 
arrived at only by discounting the prospective 
value of its future yield. The value of reproducible 
capital is influenced by two considerations; that of 
capital not reproducible, by one, 

§ 6 
Interest in a Money Economy 

It should not be difficult to translate our results 
into terms of a money and money price economy. In 
such an economy, fruit or other consumption goods 
would not be directly borrowed. The borrower 
would seek, instead, the amount of money necessary 
to purchase such goods. Trees would not be 
directly traded for fruit nor would the labor of 
planting trees be paid for in fruit. Instead, the 
seller of trees or fruit or labor would receive 
money and the buyer would pay money. But the 
ultimate result would be the same since the seller 
of one good is the buyer of another. In order to 



146 Earned and Unearned Incomes. 

make plausible the assumption of a money economy 
on Crusoe's island, let us suppose its population to 
have materially increased so that others than Cru- 
soe and the Spaniard are engaged in productive 
effort. The Spaniard now will not pay for Crusoe's 
10 trees more money than he can get for his 1000 
pieces of fruit. He might better, himself, become 
a producer of trees and let Crusoe or others go 
after fruit. Likewise, Crusoe will not intentionally 
produce the 10 trees for sale at a lower price in 
money than could be realized by the sale of 1000 
pieces of the fruit. So, also, if the Spaniard con- 
templates borrowing, not the 1000 pieces of fruit 
necessary to support life while fetching and plant- 
ing the trees, but the amount of money necessary 
to buy the fruit, he will not consent to repay 
more, as principal and interest, than the expected 
money value, next year, of the 1100 pieces of 
fruit which his present efforts will then yield him. 
Nor will Crusoe, as a lender, consent to take much 
less, since he might rather himself expend his 
money for the fruit which he would then not have 
to produce to satisfy his present desires. By so 
doing Crusoe would be relieved of the necessity 
of gathering fruit, would be able to plant trees 
instead, and could secure, next year, the reward 
of his roundabout production. With the use of 
money or without it, the rate of productivity of 
waiting is an important determinant of interest. 
If the relative difficulty of producing fruit directly 
and of producing trees remains unchanged during 
the year, that is, if the per cent marginal return 
to waiting in the industry in question is constant, 
then the relative money prices of fruit and trees 



The Rate of Interest. 147 

will remain unchanged. Unless, therefore, the 
money prices of both change, the percent gain 
from roundabout production, measured in money, 
and the rate of interest realized in money, will be 
the same, respectively, as the per cent gain and the 
rate of interest realized in fruit. In a later 
section^* reference will be made to some of the 
effects of the fluctuating value of money. But these 
effects, though they may lead us to qualify, will 
not lead us to cast aside the results of the fore- 
going analysis. The connection of the surplus 
productivity of roundabout processes as a cause 
with the rate of interest as an effect is too 
fundamental to be successfully controverted. 

§ 7 
Changing Bank Reserves in Relation to Interest 

A large amount of money carries with it in a 
modern country, a large amount of bank credit. 
A part of the money in a modern community takes 
the form of bank reserves, and the credit which 
banks can lend with safety is a more or less 
definite multiple of these reserves. Also, as a 
matter of business convenience, individuals and 
corporations preserve a more or less definite 
ratio between their cash assets and their checking 
or commercial bank credit accounts.^^ If, there- 
fore, the quantity of money should double, we might 
very reasonably expect the volume of bank credit 
to double likewise, and prices to double. The new 

24 §8. 

2'5 See Fisher, The Purchasing Poiver of Money, New York (Mac- 
millan), 1913, pp- 50-52. 



148 Earned and Unearned Incomes. 

condition of equilibrium, when reached, would be 
one in which the amount of money in circulation, 
the volume of bank credit, and the amount of 
money in bank reserves, were all larger in the 
same proportion (double) and in which, therefore, 
these quantities had the same ratios each to each 
as before the increase.-^ With a large quantity 
of money, interest would be the same as if there 
were less money^^ and with a change in the 
quantity of money interest would eventually be the 
same as if the quantity of money had not changed. 
But with a change in the quantity of money there 
are likely to be certain disturbing transitional 
effects on the loan rate of interest, to which at 
least brief consideration ought to be devoted. 

When the amount of money increases rapidly, 
and largely, the new money goes at first, for 
the most part, into the banks. If it comes from 
the mines, the mine owners can do little else than 
deposit it. Even if they put the money into 
various investments, the receivers of the money 
can do little else than deposit it in commercial 
banks. They may choose to use a fifth or a 
tenth of it as money in current transactions, but 
they will probably prefer for their larger trans- 
actions to use checks. Hence bank reserves are 
pretty likely to be increased, at the start, more 
than money in circulation outside the banks is 

2s Assuming, of course, that other conditions did not meanwhile 
so change as to make a new equilibrium the normal one. 

27 The notion that loan interest would be reduced because there 
would be more money to lend, comes from overlooking the fact that 
with higher prices correspondingly more must be borrowed. See 
Fisher, The Rate of Interest, New York (Macmillan), 1907, p. 8. 



The Rate of Interest. 149 

increased. The case is substantially similar when 
gold flows into any one country from abroad. 
During two years of the present world war, while 
the United States was neutral, a tremendous 
excess of exports from, over imports to, the 
United States brought a very large inflow of 
gold. But the exporters did not want the balances 
due them in the form of gold or money. They 
desired some money but mostly checking accounts. 
They sold to the banks their drafts on the foreign 
purchasers of American goods, and accepted 
credit accounts with the banks and such cash for 
small transactions as they needed. The banks 
received the imported gold. The ratio of money 
in banks to money in circulation was large; the 
ratio of bank reserves to bank deposits (checking 
accounts) was larger than would otherwise prob- 
ably have been the case. There were said to be 
surplus bank reserves. 

Of course this condition is not permanent. The 
larger reserves must eventually mean more bank 
credit, i. e. a larger volume of checking accounts. 
The larger volume of bank credit must mean 
larger cash withdrawals. As we have just seen, 
the eventual new condition of equilibrium is one 
of increased money in circulation, proportionately 
increased bank reserves, proportionately increased 
bank credit, and higher prices. But how does all 
this come about? Must it not be through a bank 
discount (interest) rate sufficiently favorable to 
encourage borrowing? The banks have excess 
reserves and, therefore, large lending power. It 
is their particular business to make loans, and it 
is more profitable for them to loan at fairly low 



150 Earned and Unearned Incomes. 

rates than for them to hold excessive idle reserves. 
Gradually the favorable rate on loans encourages 
borrowing, bank credit expands, prices rise and, 
when bank reserves are no longer in excess, bank 
discount (interest) rates rise also. So, too, bank 
discount (interest) fluctuates with the change 
from business depression to business activity as 
bank reserves are alternately excessive and barely 
adequate. The ultimate long run influences on the 
rate of interest are those we have discussed in 
the previous chapter and the preceding sections 
of this chapter.^* But the fluctuations in the loan 
rate are closely connected with the fluctuations in 
general business activity, seasonal changes, changes 
in the quantity of money and, going along with 
these or because of these, changes in the per cent 
of bank reserves to bank deposits (checking 
accounts) . 

An increased quantity of money in bank reserves 
may not for several months or, perhaps, even 
years, bring about the eventual corresponding 
increase in bank credit and the incident rise of 
prices. The borrowing business man has, ordinarily, 
a certain notion of how much business he wishes 
to do and how large a stock of goods or how much 

28 To which should be added, the influence of the sporadic wait- 
ing made available by the institution of commercial banking, which 
places at the disposal of borrowers funds of depositors which would 
otherwise be idle for various indeterminate periods and tends thus 
somewhat to reduce the marginal productivity of waiting. More 
capital of other sorts can be produced because credit has been substi- 
tuted for the more expensive specie. But marginal productivity 
remains a determining force in fixing interest. See the author's 
Principles of Commerce, New York (Macmillan), 191 6, Part I, 
Chapter II, §§ 3, 4 and 5. 



The Rate of Interest. 151 

labor he wants to buy. To carry out his plans he 
needs a certain amount of funds larger or smaller 
according to the prices of what he has to buy. 
Until bank credit has expanded proportionately to 
the increase of money, prices will not rise in the 
degree to be eventually expected. But until prices 
do so rise, the business-man borrower does not need 
to seek much more than his ordinary credit to carry 
on his ordinary business. The level of prices de- 
pends largely upon the volume of bank credit but 
the amount of bank credit depends in considerable 
measure upon the level of prices. Nevertheless we 
are not absolutely caught in an endless circle. 
Favorable discount rates will encourage business 
men to borrow and endeavor to expand their busi- 
ness. But when the industrial world is fully oc- 
cupied, the endeavor of its different units to expand 
can hardly result in a general expansion. Different 
business men bid against each other for labor, for 
raw materials, for structural goods, and prices rise. 
The rise of prices necessitates more borrowing, 
even if, in individual cases, there is no expansion. 
The favorable discount rates still encourage to at- 
tempted expansion and to the further borrowing 
which such expansion implies. At length per cent 
reserves are reduced, credit is expanded to its nor- 
mal ratio to reserves and to money in circulation, 
prices are high, and men must borrow largely to 
do an ordinary business at these high prices. In- 
terest rises, and, if bank reserves become inade- 
quate or nearly so, may have to rise to a point as 
much above its usual level as it previously was be- 
low. We may, however, think of these various 
changes in bank discount rates as fluctuations above 



152 Earned and Unearned Incomes. 

and below an average or normal rate. Further- 
more, the bank discount rate is purely a loan rate. 
It is not necessarily the rate at which present 
goods and future exchange for each other when 
capital instruments are sold. It is not necessarily, 
in other words, the same as the rate of return real- 
ized by the owners of capital,^^ although it tends, 
in the long run, to approximate that rate. When 
loan interest is, for any such special reason as in- 
creased bank reserves, temporarily abnormally low, 
this does not mean that the interest earned by capi- 
tal is low but only that borrowers are profiting at 
the expense of lenders, realizing large or moderate 
returns on the capital of others and paying low 
rates for the privilege. 

§ 8 
Rising and Falling Prices in Relation to Interest 

To illustrate the relation of rising and falling 
prices to the interest problem, let us take the case 
of a man who, for $6,000, buys a house. If, as a 
consequence of increasing gold production or ex- 
pansion of credit or both, prices rise, in five years, 
by 50 per cent, and if this rise is a general one 
applying to houses as well as to other things, then 
his house, at the end of five years, will be worth 
$9,000.^° The owner will have had the annual use 
of the house, or its annual rent at a progressively 
higher rate, and can now sell it for an increase of 
50 per cent over the purchase price. Nevertheless, 

29 In excess of their wages of management. 
^° Making no allowance for depreciation. 



The Rate of Interest. 153 

on the supposition that other prices have gone up 
in like ratio he is no better off than before. He 
has 50 per cent more money than he otherwise 
would but also the things he wants to buy cost 50 
per cent more. Similarly, if prices fell, so that his 
house would sell for only 2/3 of the purchase price, 
or $4,000, this fall would carry with it no loss, 
since the $4,000 would buy as much at the lower 
prices as the $6,000 would originally buy. 

But with prices rising the annual money rents 
received for the use of the house, if rented, would 
come to be a larger per cent of its original cost; 
while with prices falling they would become a 
smaller per cent. The actual gain on investment 
may be the same in either case, but the gain meas- 
ured in money bears in one case a larger and in 
the other case a smaller ratio to the original money 
value of the property. Hence, in a nominal sense, 
the interest received by the directing owner of 
capital is higher in periods of rising prices and 
lower in periods of falling prices. It should be em- 
phasized that the interest here in question is the 
"implicit"^^ interest received by investors who di- 
rectly purchase income-yielding capital; "explicit'' 
or loan interest is not meant. 

A consideration of the rate of interest on loans 
in a period of rising or one of falling prices, raises 
the question of the relative gain or loss from price 
changes of the borrower and the lender. Let us 
turn again to the hypothesis of a 50 per cent rise 
of prices and its effect on the purchaser of a $6,000 
house; but let us now assume that $4,000 was bor- 

31 A term used by Fisher, The Rate of Interest, pp. lo and n. 



154 Earned and Unearned Incomes. 

rowed at (say) 6 per cent interest, the principal 
to be repaid in five years. In the meanwhile the 
lender receives $240 a year (6 per cent of $4,000), 
which the borrower can presumably pay, while still 
making something for himself, out of the gradually 
rising rent of the house. And at the end of the five 
years, when the property sells for $9,000, the titu- 
lar owner has to pay only $4,000 to the person who 
made the loan, $4,000 which will buy much less 
than it would have bought when lent five years be- 
fore. The titular owner himself keeps the other 
$5,000, a sum which makes good his personal in- 
vestment of $2,000, together with the loss from 
the depreciation of money, and, in addition, gives 
him a substantial profit at the expense of the lend- 
er. Had the lender been familiar with the fact 
that money is not constant in value, had he fore- 
seen the rise of prices, and, having the alternative 
of himself investing his money in a house or other- 
wise, had he refused to lend except for an interest 
return enough above the 6 per cent to compensate 
him for the depreciated value of the money he 
would later receive, the borrower would not have 
been able thus to gain at his expense. Indeed, as 
Professor Fisher has shown, ^^ there is some ten- 
dency for rising prices, if long continued, to in- 
crease the rate of interest paid on loans, because, 
although the depreciation of money may not be 
consciously recognized as such, yet the profits of 
extending investment on borrowed money during 
such a period of rising prices are so tempting as 
appreciably to increase the demand for loans and, 

32 The Rate of Interest, Chapter XIV. 



The Rate of Interest. 155 

probably, to decrease the supply. More persons 
wish to borrow in order to invest. Fewer persons 
wish to lend for the investment of others. There 
is likely to be, therefore, when the rise of prices is 
at all prolonged, a marked tendency for loan in- 
terest to go up. 

The statement that rising prices, if long enough 
continued, cause the rate of loan interest measured 
in money to rise, should not be regarded as incon- 
sistent with the view previously presented^" that a 
large and rapid increase in the amount of money 
is likely, at first, to reduce the bank rates of dis- 
count by creating large reserves. The higher rate 
of interest on loans should be regarded as a later 
effect of increasing money. The probable sequence 
would be: increase of money; increase of bank 
reserves; low discount rates on loans from com- 
mercial banks ;^* expansion of bank credit; rising 
prices; rising interest and discount rates. 

On the other hand a fall of prices such that in 
five years the house and lot of our illustration 
would sell for only $4,000 instead of the $6,000 
originally paid for it would mean, not only that 
the lender would get his $240 a year regardless of 
the fact that the rent of the house was progressive- 
ly declining, but also that at the end of the five 
years the house and lot would sell for barely enough 
to pay him his principal. His $4,000, however, 
would buy very considerably more than the $4,000 
he lent, while the borrower's $2,000 margin would 
be reduced to nothing. Falling prices, therefore, 

33 § 7 of this Chapter (V). 

34 Influencing, of course, the general rate of interest on loans. 



156 Earned and Unearned Incomes. 

call for and, in the long run, probably bring, lower 
rates of money interest^ ^ to compensate for the 
greater difficulty of repaying the principal. But 
changes in the value of money are inadequately 
realized and seldom accurately foreseen, and it 
therefore follows that the relations between borrow- 
ers and lenders are seriously disturbed by such 
changes. A money and credit system so adjusted 
to trade as to keep the average price level always 
constant would for this as well as for other reasons 
have advantages over the present fluctuating cur- 
rency.^^ 

§ 9 

Some Further Complications in the Actual Indus- 
trial World 

A number of additional refinements must be 
added to the theory of interest as thus far present- 
ed, in order to make this theory fit the complica- 
tions of actual life. In the first place, we can not 
properly assume for the real economic world, as 
we have been assuming, for the sake of simplicity, 
in much of the preceding discussion, that the mar- 

25 It is not improbable that a decrease in the amount of money or 
a decrease of money in proportion to business, would first show 
itself in comparative insufficiency of bank reserves and temporarily 
higher discount rates, this condition being followed by a decrease 
or relative decrease of bank credit and by falling prices, and the 
falling prices leading to a decrease of demand for loans and, hence, 
to a lower rate of interest on money. 

36 See The Purchasing Poiuer of Money, by Irving Fisher, assisted 
by Harry G. Brown, New York (Macmillan), 1913, Chapter XIII, 
for a discussion of various methods of making the price level more 
stable. 



The Rate of Interest 157 

ginal gain from roundabout production will be alike 
10 per cent or 5 per cent or any per cent for all 
actual and potential producers, without regard to 
whether they have access to the loan market. Ca- 
pabilities and aptitudes differ. Marginal round- 
about production might yield, for one man, making 
use only of his own saving or waiting, 10 per cent 
over the yield of direct production ; while for another 
man, making use of all his own waiting and no 
more, the yield might be only 4 per cent. The 
yield to the second man might be smaller because 
he had saved more and had to carry roundabout 
production to a lower margin. Or it might be 
smaller because he was less efficient in roundabout 
production or because he was more efficient in 
direct production. In any such case both would 
gain by the possibility of a loan. If both have 
saved equally while the first producer can gain a 
larger per cent from roundabout production, the 
first can profitably borrow and the second can 
profitably lend. So, likewise, if the second has 
saved so much that his waiting, directed by himself, 
can produce, at the margin, but little return, it 
will be advantageous to him to lend to someone 
who can make his waiting produce more. In that 
case he will not carry his own use of capital to such 
a point as to bring the marginal yield below the 
interest he can realize by lending. The first pro- 
ducer, whether the large gain he can realize from 
roundabout production is due to his having saved lit- 
tle or to his being relatively proficient in directing a 
roundabout process, will find it worth while to 
borrow at the prevailing rate and to carry round- 
about production to a point such that the yield 



158 Earned and Unearned Incomes 

from its further extension under his direction 
would not be in excess of the rate at which he 
could borrow. Thus, the marginal productivity of 
capital or of waiting, for each producer who directs 
the use of capital, tends to approximate the rate 
of interest at which he can lend or the rate at 
which he can borrow. If everyone could give 
equally good security and could, therefore, borrow 
at the same rate, the marginal productivity of 
waiting would tend to be the same for all pro- 
ducers and all lines of production. 

In the second place, we must somewhat qualify 
our conclusions regarding the determination of 
the value of capital, though not in such a way as 
to affect the main principles contended for. We 
have said that interest is some per cent, e. g. 
6 per cent, because capital instruments the values 
of which are measured by the alternative goods 
that could be produced by the same labor, working 
with an equivalent equipment of land and tools, 
yield 6 per cent. Thus a railroad, some barns, 
some mills and some machinery, taken all together, 
would be said to be worth in the long run a 
certain amount in terms of consumable goods or 
of money exchangeable for such goods, because, 
were they to be worth any less, the labor, etc., 
turned to their construction would find it more 
profitable to turn, in part, to the production of 
consumable goods. In the real economic world, 
with the diverse inherited abilities of its members 
and the different kinds and degrees of acquired 
skill, many producers practically have not the 
alternative of changing employments. But so 
many can change their employments and the choices 



The Rate of Interest 159 

of those persons just about to enter the ranks 
of industry are so important, that the value of 
various kinds of capital is related, through their 
alternatives, to the value of consumable goods. 
In like manner the value of consumable goods is 
related to the value of capital. Since producers of 
one kind of goods usually have different aptitudes 
than producers of another kind, we cannot say 
that the value of any capital must exactly equal 
the value of the present goods which the same 
labor or an identical quantity of labor would 
produce. But that there is a close relation between 
the two, due to the existence, for many producers, 
of alternatives, cannot be gainsaid. Stating the 
matter roughly and assuming the above qualifica- 
tion to-be made, we may say that the (marginaPO 
product of labor devoted to the construction of 
capital equipment will exchange for the (marginal) 
product of an equal amount of labor devoted to 
the production of consumable goods.^^ Of course, 

^'^ For explanation and more complete discussion of the "marginal" 
product of labor, see Chapter VII. 

38 If A buys from B a piece of capital which it requires (say) a 
year to make, the price paid for the capital will of course be dif- 
ferent according as the payment is made from day to day to support 
B while he is making it (wages) or at the end of the year when 
it is complete. In the former case A would be willing to pay the 
amount of current goods which labor equivalent to that of producing 
the capital could alternatively produce. In the latter case, if A had 
contracted at the beginning of the year to buy the capital of B at 
the end of the year, the amount he would have been willing to offer 
would be, not the amount of goods he could have currently produced 
by a direct process but the amount he could have produced by the 
most effective roundabout process available which would neverthe- 
less yield its entire product by the end of the year. But if A does 



160 Earned and Unearned Incomes 

also, if capital of any special kind is constructed 
in such excess as to make its surplus marginal 
productivity less than that of capital in general, 
its salable value will come to be less, while it 
is thus in excess, than its cost of production. But 
the tendency will be for the construction of such 
capital to cease until its value again reaches its 
cost. 

It is understood that the labor devoted to produc- 
ing consumable goods uses existing equipment 
and that, if it did not have any such equipment 
its marginal product might be very much less. Like- 
wise the labor devoted to making equipment uses 
preexisting equipment in so doing. It is, indeed, 
clear that, in general, industry is immensely more 
productive with capital than it could possibly be 
if there were no capital. The marginal products of 
the other factors are greater the larger are the 
accumulations of capital of which these other 
factors can make advantageous use, while the 
marginal productivity of waiting is diminished 

not decide to buy the capital until the end of the year he makes 
his decision when there is no longer open to him the alternative of 
himself producing it and enjoying its use equally early- Neverthe- 
less, the opportunity to make choices among all the options here sug- 
gested continually recurs and is of importance in the determination 
of capital value. There is also the option, for A, of combining his 
effort with that of others so as to produce the capital in less than a 
year. In that case it is only partly his but also he has only paid part 
of its cost. The possible options significant for the interest problem 
include, of course, not only the choice between direct and roundabout 
production but also, as suggested above in this note, choices between 
longer and shorter roundabout processes. These choices, too, are 
choices between larger and smaller later incomes as much as they 
are choices between earlier and later incomes. 



The Rate of Interest 161 

and the rate of interest lowered. That capital 
should be accumulated is important, therefore, 
even to those persons who cannot themselves save 
any. Likewise, in a community which has large 
accumulations of capital and in which, consequently, 
the productivity and price of other factors is 
high, the individual business man cannot afford 
not to use capital. Were an employer of labor 
to use no capital at all in his business, the product 
turned out by his employees would seldom or never 
pay their wages. Nor would this product probably 
pay the rent charged by the owner of the site used. 
The difference between using and not using capital 
might therefore be the difference between swift 
failure and measurable success. But the difference 
between using a little more or a little less capital 
would be of comparative unimportance and might 
be a difference of only 10 or 5 per cent of the 
additional increment used.^^ In modern production 
there is practically always more than one factor; 
usually there are three. Whatever may have been 
true of primitive man, modern man always uses 
tools. He uses tools to make tools and buildings 
to make the structural material for more build- 
ings. The point here to be emphasized is that, 
in the case of a man who is marginal between the 
two employments, what his labor can add to the 
equipment of society which existing equipment 
cooperating with other labor would produce without 
him, will exchange for what his labor could add 
to the consumable goods or services available to 



39 Cf. Jevons, The Theory of Political Economy, fourth edition, 
London (Macmillan), 1911, pp. 256-259. 



162 Earned and Unearned Incomes 

society, which existing equipment cooperating with 
other labor would produce without him. Since goods 
are produced by land, labor and capital acting in 
conjunction, and since this is as true in the 
production of more capital as in the production 
of consumable goods, we must broaden our state- 
ment if it is to make proper reference to land 
and capital as factors in the production of addition- 
al capital. Let us say, then, that the value of 
any capital will be equal to the amount of con- 
sumable goods which the labor and the land and 
the capital used in producing the additional capital 
in question could produce,^° assuming each of 
these factors to be used in its most profitable 
alternative way. And the fact that capital of a 
certain value determined as has been herein set 
forth will yield a given income, is a reason why 
interest on loans is a given per cent. 

In the third place, attention should be called to 
the fact that, in a modern community, to a 
considerable percentage of business men, invest- 
ment and, therefore, capitalistic or roundabout 
production does not involve primarily manufactur- 
ing but has to do rather with merchandising. 
Hence roundabout production may, for them, in- 
volve other investment outlays in addition to those 
for the provision of such material equipment as 
stores, delivery trucks, etc. These other outlays 
of the merchant — and of the manufacturer in so 
far as he must devote a part of his attention to 
the mere selling of his goods at a profit, as 

*o The labor, land and capital here considered are assumed to be, 
each, not specialized but marginal between two uses. 



The Rate of Interest 163 

distinguished from the manufacture of them — 
include, for example, outlays for the building up 
of goodwill, among which advertising is perhaps 
the most important. Competitive advertising may, 
indeed, be a waste of a community's labor time. 
The argument currently advanced that it enables 
a merchant or manufacturer to sell more cheaply 
because of the increased volume of his business 
may be applicable in the case of any one merchant 
or manufacturer who advertises, as contrasted with 
the prices he would have to charge if he did not 
advertise. But when the advertising is done by 
all sellers in any line the result may well be that, 
on the average, their business is no larger while 
the expense of doing it is greater, so that the 
charges for the goods sold must be higher. Even 
if each of the sellers of these goods, by virtue of 
advertising, sells more than before, the increased 
purchases by the public in this line, thus stimulated 
by advertising, inevitably mean less purchased 
in other lines. It is difficult to see, therefore, 
how competitive advertising, except so far as it 
may be a necessary means of developing intelligent 
discrimination among purchasers and so some- 
what stimulating rivalry among producers, can be 
anything but wasted effort. The time may come 
when, for its own protection against increasing 
costs of distributing products, the public will 
establish and enforce a maximum limit to advertis- 
ing, will fix, as it were, a plane of competition in 
advertising, just as it endeavors to fix a plane of 
competition as regards employment of child labor, 
price discrimination, railroad rebates, etc. How- 
ever this may be, advertising is an investment 



164 Earned and Unearned Incomes 

which, for the individual concern which engages 
in it, is often well worth while. For such a 
concern it is productive. And for such a concern 
the building up of goodwill in this way, from 
which profitable results are expected in the 
future rather than at once, is clearly a case of 
roundabout production. It might well be financially 
advantageous to borrow the funds for the purpose 
and pay interest on them. The labor and other 
factors employed in advertising are employed 
analogously to the labor and other factors used 
in constructing material equipment. The purpose 
is, not to change the form of wood, iron, etc., 
as in the latter type of operation, but to change 
the mental processes of potential purchasers of 
certain goods. The labor devoted to doing this 
does not directly and immediately produce its 
own food and clothing or, even, the sales which 
bring money income (exchangeable for food and 
clothing) to the employing firm. To keep this labor 
thus employed in a roundabout process which 
yields a greater but a less early return than 
direct activity would yield, current means of 
livelihood must be provided to those so employed. 
The persons who furnish newspaper plant and 
other equipment for the purpose must also receive 
payment in the form of purchasing power ex- 
changeable for a certain amount of subsistence.*^ 

*i In this connection it may be well to point out that the expendi- 
tures of a government for war purposes are, in a sense, expenditures 
for roundabout production. The army of a dynastic or imperialistic 
state is maintained as a means to the realization of dynastic or 
imperialistic aims. A democratic nation may wage war for the 
perpetuation of democratic institutions. In either case, the food, 



The Rate of Interest 165 

As always, of course, when wages and other 
payments are made in money, the persons receiv- 
ing these payments may, if they choose, spend the 
sums received for capital. But if they do they 
are receiving future goods for future rather than 
present goods for future and the rate at which 
present goods exchange for future has in the 
circumstances, no particular significance. In pass- 
ing, mention may be made of the fact that sub- 
sistence, etc., used to make possible leisure from 
direct production and the devoting of time to 
securing general education or technical training 
may be said, often, with truth, to be used for 
roundabout production. 

§ 10 

Interest Earned and Unearned 

Roundabout production may and often does 
involve exploitation. Thus, a manufacturing con- 
cern the dividends of which will be enhanced if it 
can, in future, be assured of freedom from com- 

clothing and munitions furnished the soldiers make it possible for 
them to devote themselves to ends more or less remote but, in the 
view of their government, ultimately desirable ends, as distinct 
from devoting themselves to the immediate production of consuma- 
ble goods. But, of course, the providing of millions of soldiers 
with goods which are immediately consumed and destroyed makes 
it impossible to provide so many producers with the means requisite 
to carry on roundabout industrial processes, tends to raise the 
surplus marginal product of roundabout production and tends 
towards higher interest rates. Means of defense are necessary and 
clearly justifiable for a nation surrounded by armed potential foes; 
yet it is also clear that from the point of view of ivorld economy, 
competitive military and naval establishments are not instruments of 
production but merely very heavy burdens. 



166 Earned and Unearned Incomes 

petition with foreign rivals, will be, from the 
point of view of its stockholders, engaged in 
roundabout production when it pays for advertis- 
ing space in newspapers to create a general senti- 
ment in favor of the tariff as a wage-raising 
device, contributes openly or by indirection to a 
political campaign fund, and hires lobbyists to 
care for the particular schedules in which it is 
interested. All of the labor and other factors so 
employed must be paid what the market condi- 
tions require and therefore must be paid not less 
than they could secure in direct production. The 
activities of these factors are expected to yield 
larger eventual returns to the employing company 
than if they were used in selling or in producing 
immediately salable goods. Did the company 
borrow to carry out such a policy, the borrowing 
clearly would not be the result of a desire upon 
the part of the company's stockholders to secure 
present consumable goods for their own con- 
sumption but because the control of present 
consumable g"oods (or the funds to purchase 
them) enables the company to employ in a 
relatively long-time process labor and other factors 
which might else have been employed in more direct 
production,*^ and to reap a gain in so doing. The 
company's demand for funds has resulted, not 
from preference for present goods over future 
but from preference for a larger future income over 
a smaller future income. Clearly, the gain from 
roundabout production is not necessarily a social 

*2 Or in roundabout production for some other employing company, 
thus displacing another set of employees and equipment for more 
direct production. 



The Rate of Interest 167 

gain. Exploitation of the masses by a plutocracy 
may be, in part, exploitation by a roundabout 
process. Income so secured is not earned by 
service rendered, although, of course, the owners 
of the funds used receive their interest return for 
rendering a service to those who are rendering the 
public a disservice. Income derived from the use 
in serving the public, of funds accumulated by the 
saving of gains themselves legitimate, is earned. 
Income secured by injuring or assisting in injuring 
the public should be terminated so far as is 
reasonably possible, by effectively prohibiting 
exploitive activities. 

It should now be clear that, if all possible 
anti-social uses of capital were effectively for- 
bidden, interest on capital would be earned as 
truly as, under like circumstances, the wages of 
labor would be earned. The person who had 
accumulated capital, who had, by his saving, 
brought into existence capital which, except for 
him, would never have come into existence, and 
who thereby had made possible an addition to the 
current product of industry, would have earned, 
in the sense of giving a quid pro quo, interest on 
this capital. Such interest, contrary to the view 
of Marxian socialists who include all interest in 
what they call ''surplus value" is in no sense 
exploitation. There is, indeed, far too much 
exploitation in the modern industrial world. The 
nature of some of this exploitation has already 
been explained in this and the previous chapter 
and attention will, as we proceed, be devoted to 
exploitation of other kinds. But that interest, 
purely as such, is necessarily exploitation, is a claim 



168 Earned and Unearned Incomes 

which neither the socialists nor anyone else can 
substantiate.*^ 

§11 

Summary 

The interest rate in a modern community is a 
result of the influence of many alternatives of 
many individuals. A person may lend or borrow, 
he may buy capital with consumable goods or 
sell capital for consumable goods, he may engage 
in relatively roundabout or relatively direct pro- 
duction. The rate at which present goods ex- 
change for future goods outside of loan contracts, 
is a part of the same problem. The value of 

*3 Nor do owners of capital as such, have any advantage over the 
rest of the community in the ability to profit beyond their own con- 
tributions by the accumulated technological knowledge of the race. 
(That they do have this advantage seems to be asserted by Professor 
Thorstein Veblen in The Instinct of Workmanship, New York, — 
Macmillan — , 1914, p. 281.) In this regard, not they alone but all 
of us of the present generation, reap where we have never sown. 
Labor or land, as well as capital, may thus be rendered more produc- 
tive than in the past. But in truth, if the capital from <which any 
person derives interest ivas itself fairly earned and is used in socially 
desirable ivays, its use adds to the productiveness of industry, over 
and above what all the land, labor and other capital of the commun- 
ity could, in the prevailing state of technological information, have 
produced without it, all that its owner receives as interest. His gain 
leaves to the rest of the community all that the intellectual equip- 
ment of the race could have produced without his accumulation. 
He reaps only the additional value output which would not have re- 
sulted except for him. And in proportion as large amounts of capi- 
tal have been accumulated and its marginal productivity and interest 
so reduced, the tendency is for others than the owners of capital 
to profit greatly from industrial progress and from capital con- 
struction. 



The Rate of Interest 169 

capital is influenced by the rate of impatience or 
time preference at which its expected future 
benefits are discounted but also by the fact that 
the labor, etc., devoted to the production of this 
capital might have been devoted, instead, to the 
production of other and more immediately con- 
sumable goods. In a broad sense the owner and 
user of capital, no less than its owner and lender, 
enjoys interest. We may, with some gain in clear- 
ness, regard the surplus of roundabout over 
direct production, at the point beyond which 
roundabout production is not extended, as the 
marginal product of abstinence or waiting, since 
it is abstinence or waiting that makes this gain 
possible and since capital is not an ultimate 
factor. The gain is less the farther abstinence 
or waiting is carried. But the rate of interest 
tends to equal the per cent of this gain. A rate 
of interest higher than the marginal product of 
waiting must cause the demand for waiting by 
those who would purchase it (offering future 
goods for present) to be less than the supply 
offered by those who would sell it. Likewise a 
rate of interest lower than the marginal product 
of waiting must cause the demand for waiting to 
be in excess of the supply. Only at a rate of 
interest equalling the marginal product of wait- 
ing can we expect the demand for and the supply 
of waiting to be equalized. Such a rate will, of 
course, be higher than the marginal yield which 
some men could secure from their waiting did the> 
insist on making use of all of it in business 
directed by themselves. These men will usually 
prefer to be lenders. The equalizing rate will be 



170 Earned and Unearned Incomes 

lower than the marginal product which other 
men could secure if they used their own waiting 
alone. These other men will usually be borrowers. 
Thus, the waiting done by men in excess of their 
own profitable use may be made advantageous 
both to themselves and to others. The rate of 
interest clears the market in exchange of present 
for future goods, equalizes or tends to equalize the 
time-preference or impatience rates of those who 
have access to the market, equalizes or tends to 
equalize the marginal productivity of waiting for 
different persons who have occasion to make use of 
waiting and who are able, through the market, to 
buy and sell it at approximately equal rates, and, 
also, equalizes or tends to equalize the marginal 
productivity of waiting for different lines of 
production. Roundabout production need not in- 
volve material equipment but is exemplified in 
advertising, lobbying, and other non-technological 
activities. Roundabout production may be "pro- 
duction'* only in the sense of exploiting the public 
for the benefit of a few, in which case the interest 
received can hardly be regarded as earned by 
equivalent service given. Fluctuating bank reserves 
and rising and falling prices are likely to cause 
fluctuations in loan interest but do not necessarily 
affect the real incomes received by owners of 
capital who themselves direct its use. It is the 
real incomes from capital which, in the long run, 
tend to fix the rate of interest on loans. 



CHAPTER V 

WAGES AND POPULATION 

§ 1 
The Proximate Determination of Wages 

The larger part of the incomes of the majority 
of persons, though not of those whose incomes 
are the greatest, are incomes from labor. Some 
incomes from labor, usually those received for the 
work requiring least of physical exertion, we 
call salaries. Other incomes, really the direct 
result of labor, we call proprietors' or enterprisers' 
profits. The part of a proprietor's income which 
is derived from capital investment is then assumed 
to be excluded from consideration. It is assumed 
that a portion of his total income is due to or 
attributable to his possession of capital and 
another portion to his mental and physical efforts. 
He may, also, receive accidental gains and suffer 
accidental losses, accidental in the sense that 
some proprietors gain and others lose when, so 
far as intelligent observers can see, managerial 
ability and application is not correspondingly un- 
equal. For our purposes, all of the returns properly 
attributable to labor or effort may be lumped 
together as wages. 

What we seek is a knowledge of the forces that 
fix wages in any special line of work and with 
that, as a by-product of our narrower study, a 
knowledge of what fixes wages in general. We 
shall find the law of wages to be analogous to the 

(171) 



172 Earned and Unearned Incomes 

law of interest, and the approach to an under- 
standing of the law to be through similar avenues. 
Wages, like interest, are fixed by demand and 
supply, and whatever more ultimate forces act 
upon them act through demand and supply. If, at 
wages of $2 a day in any line, more men are 
wanted in that line than are to be had, the 
resultant bidding tends to raise the wages until 
the demand is no longer in excess of the supply. 
On the other hand, if, at wages of $3 a day, the 
supply of labor of the sort in question is in 
excess of the demand, then the seeking of employ- 
ment by would-be wage earners in that sort of 
labor must tend to lower wages to a point where 
supply no longer exceeds demand.^ 

1 Some interest attaches to the question ol whence comes the ulti- 
mate demand for labor. It is unquestionably true that, consider- 
ing economic society as made up of groups producing for each other 
under modern division of labor, the demand for any special kind of 
labor traces back of the employer to the purchasers of the goods 
made, or in other words, to wage earners, etc., in other lines who de- 
sire this special kind of goods and who, indirectly, are trading for 
them goods which their labor or their line of industry produces. 
In this view the labor of some constitutes a demand for the labor 
of others, just as the supply of some goods is said to constitute a 
demand for other goods. But while no one can demand goods 
without, in effect, offering other goods in exchange for them, it is 
certainly possible to demand labor, in the sense of being a buyer 
of labor, while yet not offering labor in return. Any capitalist or 
landowner can turn the trick. His purchases represent a demand 
for labor but not a supply, a demand for one kind of labor which 
does not emanate from a supply of another kind. 

There are, indeed, advantages from the point of view of a dis- 
cussion of general wages, in thinking of all labor as offering its 
services to owners of property and owners of property as buying these 
services. VV^ith a division of society into the two classes of property 
owners and laborers, with free contract, but with no markets and 



Wages and Population 173 

Let us devote brief attention to some line of 
industry and attempt, for that industry, to see 
what wage-determining factors lie immediately 
back of demand and supply. For purposes of 
illustration, we shall examine the wage-determining 
influences in a hypothetical, small community, the 
only industry of which is the raising of wheat. 
In this community are five farms of various 
degrees of fertility and having various equipment. 
We shall suppose the size of farms and the equip- 
ment of each farm to be, for our present problem, 
a fixed fact. There is in the community a definite 
number of laborers of equal efficiency. On either 
one of two of the farms, which we shall call, 
respectively, A and B, 3 men can produce 1500 

no exchanges of goods, the property owners would find It advanta- 
geous to employ the laborers, agreeing to give the latter a part of the 
total product of industry and keeping a part for themselves. It is 
the relation of the propertied classes to wage earners which we have 
or should have in mind when we speak of wages in general as 
rising or falling in relation to other distributive shares and when 
we speak of changes in the general demand for labor. It was 
the relation of wage earners to capitalists which Mill had in mind 
when he stated that demand for labor comes not from the purchasers 
of goods but from the capital employed in hiring labor, and that the 
purchasers of goods simply determine in what line or lines labor 
shall be employed. (See Mill, Political Economy, Book I, Chapter 
V, § 9). Were there no market for goods, the capitalist em- 
ployer, instead of hiring men to produce goods for sale and using 
the proceeds to buy other goods for himself, while his employees 
likewise used the wages which constituted their share of the product 
to buy other goods, would simply hire the labor to produce directly 
such goods as he and they wanted and pay them a share of the 
product. Presumably wages would not be so high, under this ar- 
rangement, as under the modern system of specialization of capi- 
tals and complex division of labor, since specialization makes for 
greater efficiency of production. 



174 Earned and Unearned Incomes 

bushels,^ 4 men can produce 1900 bushels, 5 men 
can produce 2200 bushels, 6 men can produce 
2450 bushels, 7 men can produce 2650 bushels. On 
each of the other three farms, 3 men can produce 
1200 bushels, 4 men can produce 1500 bushels, 5 
men can produce 1750 bushels, 6 men can produce 
1950 bushels, 7 men can produce 2100 bushels. 

The reader will notice that the product per man 
is less as the number of men working on a given 
area is greater. We have put into the numerical 
terms of our illustration the fact, with which 
every business man and every farmer is familiar, 
that after a certain degree of utilization is reached 
a larger force working with a given equipment 
and in a given space or on a given area, though 
its total production may be greater and though, 
with wages sufficiently low, its employment may be 
worth while, will not secure a product as large 
per man employed as the smaller force. It is to 
be emphasized that the above-stated law of pro- 
duction applies as certainly to work in a factory 
or an office building as on a farm. It is true that 
a given land area can be very intensively used in 
manufacturing, in mercantile business or in pro- 
fessional work, by building story upon story. 
Nevertheless, diminishing returns are realized in 
proportion to the labor involved, because of the 
progressively stronger foundations necessary v/ith 
increasing height, because of the increased elevator 
expenses, and perhaps other disadvantages. 

2 It need not be supposed that these two farms are of equal fer- 
tility. One may have greater fertility and the other more or bet- 
ter equipment. 



Wages and Population. 175 

Before attempting to go farther in explaining 
how wages would be determined in our assumed 
community, it will be worth while to call attention 
to the way in which an individual employer^ 
adjusts his business to wages. Each employer 
determines, in the light of current wages and in 
the light of the probable advantage to him of the 
services to be rendered, how many men he will 
hire. In order to give greater exactness to the 
statement we may say that each employer hires 
men up to the point where the last man hired is 
expected to be worth no more, in this employer's 
business, than the wages which the man must be 
paid.* The individual employer, except in the 

3 Who may be a capitalist, a landowner, an enterpriser using 
chiefly borrowed funds, or himself a hired servant of owners of 
property. 

* If wages must be paid before the product is sold then, obviously, 
an employee the product of whose labor is not worth, when sold, 
his wages plus the interest his employer has to pay (or forego from 
some alternative investment to pay him), is not worth hiring. Hence, 
a potential employee's service may be of much less value to an 
employer whose credit is not good and who must pay high interest 
on borrowed funds, than to an employer in a more favorable finan- 
cial condition. To the general theory of employer's demand for 
labor, as presented in the text, some one may object that an ex- 
ceptionally capable employer could gain more from the labor, as 
also from the land and the capital, used by him than could an 
employer less capable, and that, therefore, the essential problem 
relates merely to the proportioning of factors and not to the marginal 
productivity of any one or of each of the factors. But if such an 
exceptionally efficient employer could add more to the annual product 
of his business, by hiring more men, than the wages to be paid, and 
did not do it (and the same principle would apply to his borrowing 
of capital or renting land), he would not be making the most ef- 
fective use of his directing ability; he would not be choosing the 
best proportion of other factors to the amount and quality of a 



176 Earned and Unearned Incomes. 

cases where he has substantially a monopoly, has 
no appreciable influence over the price of the 
product he sells. Nor has he, so far as the wage 
earners are familiar with market conditions and 
reasonably able to take advantage of them, much 
control over the wages he has to pay. Even the 
monopolist, as to product, has competitors in the 
wages market against whom he must bid in seek- 
ing labor. In general, the individual employer can 
react to wages only by adjusting his demand for 
labor to the wages he must pay. 

Consider, now, the demand for labor, of one 
of the farm owners in our hypothetical community. 
Assuming wheat to be $1 a busheP and wages to be 
$300 a year,^ the owner of farm A could profitably 
use four men and could use five without loss. His 
demand, with wages at this level, would be for 
four or five men. With wages less than $300 he 
would want five men. With wages more than $300 
he could afford only four men.^ With wages at 
just $300, he would be indifferent whether to hire 
four men or five.^ With four men hired, th« 

particular kind of labor used in his business, viz., labor of manage- 
ment. (See Carver, The Distribution of Wealth, New York — 
Macmillan — , 1904, pp. 90-94). 

5 Net to the farm owner. 

6 Payable, we may now assume, when the product is sold. If 
the wage is payable earlier, a somewhat lower wage would be 
necessary to bring out the same demand for labor. 

'^ In practice there are intermediate possibilities, such as hiring 
a fifth man for part time. As the principle of the solution given 
in the text is not changed by this fact, it will be better not to com- 
plicate our illustration with it. 

^ Someone may object that the extra bother of dealing with and 
directing the fifth man will prove conclusive against his employ- 



Wages and Population. 177 

total product of his farm would be 1900 bushels 
or $1900 of value and his wage bill $1200, leaving 
him $700 as interest on equipment and rent on 
land. With five men employed, the total product 
of his farm would be 2200 bushels or $2200 and 
his wage bill $1500, leaving, again, $700 of 
interest on equipment and rent on land. Since the 
fifth man receives if hired, as wages, just what 
his services add to the product that would be 
secured without him, the employer's net profits 
are equally great whether this man is hired 
or not. It must not be understood that the fifth 
or last man hired is of less ability or efficiency than 
the rest. It is not that the other men produce 
more and he less. What the illustration means is 
merely that, taking all five men to be of equal 
capacity and energy, the difference between having 
five men and having four to work on the given 
farm is less than the difference between having 
four and having three. This fact is but an ex- 
emplification of the law of diminishing returns. 

Let us now suppose wages to be, not $300, but 
$400 per man. In that case the employer on 
farm A could afford to hire but four men (he 
might hire only three), making his product $1900, 

ment. But by our hypothesis the fifth man makes the total product 
$300 larger than it would be with all the other labor necessary 
except his. The $300 is, in short, a net addition. For simplicity, 
we shall suppose the labor of management, if any is required, to 
be of equal productivity and to receive equal renumeration with 
the other labor involved. If, moreover, the farm owner works on 
his farm, he counts one among the number he can use in its culti- 
vation, i. e., he is one of the four men or one of the five men em- 
ployed, and himself receives one man's wages besides interest and 
rent. 



178 Earned and Unearned Incomes. 

his wage bill $1600 and his interest and rent 
return $300. It should be clear from this illustra- 
tion that the individual employer's demand for 
men to work on a given area and with the aid of 
a given investment in equipment, is greater or less 
according as wages are less or greater. 

Obviously, the ethical justification of the work 
for which labor is hired has nothing to do with 
the economic law under discussion, so long as men 
are found who will engage in any special business 
for profit and other men can be found to work for 
them for pay. Thus, a manufacturers' association 
seeking tariff favors at the expense of the public, 
would be likely to employ a larger body of 
lobbyists, and to hire more editors and popular 
writers for the purpose of influencing public opin- 
ion and getting what they desired, if these ser- 
vices could be secured for lower pay than if 
they must be got by the offer of higher pay. In 
such work it may be difficult to tell at what point 
additional workers are just worth the wages paid 
and beyond what point further employment of skill 
is not worth while. Yet it is not to be doubted 
that the principle involved is the same.^ So, also, 
the manufacturer of a noxious drug no less than the 
manufacturer of a breakfast food, will hire men to 
work in a given factory, up to the point where 

9 The analogy with the previous illustration is closest when we 
suppose that additional writers or lobbyists would make less and less 
difference with the schedules. But if the choice were between get- 
ting the desired tariff favors or none at all and if only a trifle more 
influence was thought necessary to get these favors, then the desire 
for such additional influence might be very great whereas further 
influence beyond this might have no utility whatever. 



Wages and Population. 179 

further labor, in that factory, is worth no more 
than the wages which must be paid. 

We are now ready to take up the direct ex- 
planation of how wages are determined in our 
hypothetical community. We shall suppose the 
number of men available for employment on the 
five farms to be twenty-one. We shall arrive at 
the rate of wages in the community by assuming 
various rates and seeing how each would affect 
demand and supply of labor. Suppose, first, that 
wages are $400 a year per man. Then not more 
than four men apiece can be employed on farms 
A and B since a fifth man increases the product by 
only $300. Nor can more than three men be 
employed without loss on any of the other three 
farms. Hence, at wages of $400 per man, not 
more than seventeen men could get employment. 
At wages of $400 per man, the supply of labor 
is very decidedly in excess of demand. Rather 
than remain idle, most or all of these men would 
work for less than $400. The competitive situa- 
tion practically compels lower wages than this. 

On the other hand, wages of $250 also fail to 
satisfy the condition of equilibrium. Wages so 
low as this would make it possible for the owners 
of A and of B to employ, each, five or six men, 
while C, D and E farms could use four or five 
apiece. There would be very considerable advan- 
tage in the employment of not less than five by A 
and by B and not less than four each by C, D and 
E. Hence, there would be active bidding^*^ for 

i*^ In the absence of collusion, which would exists the less the 
larger was the community and the greater the number of employers. 



180 Earned and Unearned Incomes. 

twenty-two men and a willingness to hire, perhaps, 
twenty-seven. But, according to our assumptions, 
only twenty-one men are available. Therefore the 
demand for labor exceeds the supply and the bid- 
ding of employers must go on up to wages above 
which there is no further advantage to any em- 
ployer in seeking to get labor away from others. 
It will readily be seen that wages of about $300 
per man fulfill this condition. At wages of $300 
or not much less, it would be possible, indeed, to 
get twenty-two men employed, five each on A and 
B and four each on C, D and E. But this does 
not mean that at $300 demand exceeds supply by 
one, for none of the five employers would bid 
over $300 to get any of these men away from any 
other. Thus, with wages at about $300, five men 
might be employed on farm A, five on B, four on 
C, four on D and three on E. This would mean 
that all twenty-one men were employed, yet the 
owner of farm E would not offer any higher wages 
in order to employ a fourth man but would be 
indifferent in the matter. Hence demand would not 
be in excess of supply.^^ And the wages which 
equalize demand for and supply of labor, which 
clear the market, are wages measured by labor's 
marginal contribution when all are employed. No 
one of the wage earners will receive more than his 
labor adds to the product which would be secured 
without his participation in the productive process. 
Of course it follows that in case the workers are 



11 In practice there would be the possibility of four men dividing 
their time among five farms. The mathematical economist will 
know how to develop refinements of this sort. 



Wages and Population. 181 

of unequal efficiency, instead of being, as above 
assumed, of equal efficiency, their wages will be 
unequal, each being paid according to his output. 

Wages being thus determined, the remaining 
product on each farm, aside from the amount neces- 
sary to maintain fertility and equipment in its 
original condition, goes to interest on capital and 
rent on land. Let us suppose that the 2200 
bushels or $2200 produced on farm A is net 
product, i. e., is all in excess of necessary repair 
and depreciation charges. Then, since the wages 
of five men at $300 each, aggregate $1500, there 
is left $700 as interest and rent. We have already, 
in a previous chapter,^^ seen how interest is 
determined. If we suppose return on accumulated 
capital to be at the rate of 8 per cent and the 
investment in improvements and equipment on 
farm A to be $5,000, then $400 of the product can 
be attributed to invested capital, leaving $300 as 
rent of the unimproved land. Capitalizing this 
rent on an 8 per cent, basis, we arrive at a value 
for the land exclusive of improvements, of $3,750. 

Each wage earner gets, as wages, in a fair 
competitive market, what his labor adds to the 
product that would have been secured without 
him. And each accumulator of capital gets, as 
interest on that capital, what his accumulation 
thus adds to the product that would have been 
secured without the aid of his capital. But if, 
through the spread of habits of saving, the volume 
of capital increases while the number of wage 
earners does not, each wage earner's efforts will 

12 Chapter IV, 



182 Earned and Unearned Incomes. 

add more than previously to the product that 
would have been secured without those efforts and 
hence wages will be higher,^^ while, on the other 
hand, the marginal product of capital will be 
reduced and hence the rate of interest will be 
lower. It is desirable, therefore, even in the 
interest of those who themselves save no capital, 
that capital should be saved. 

It should be added that proprietors' profits, the 
reward of self-employed managerial effort, are 
subject to the same law as other wages, i. e. they 
depend on the value productivity of the work done. 
If managerial ability of the highest order is scarce, 
its marginal product is large and profits will be 
large. If it is plentiful, its marginal product is 
less and competition must tend to lower profits. 
Managerial ability is sometimes, however, devoted 
to achieving success by price discrimination, by 
spreading false and malicious reports regarding 
rival goods, by making arrangements with rail- 
roads (rate discrimination) or with tradesmen 
which operate to exclude competitors' goods from 
the market, or by conspiring with competitors to 
form a monopoly and raise prices. Clearly, profits 
thus secured are related to the value of the services 
given to the public, only in the sense that the 
services given have a high value because the 
exclusion of competition forces the public to pay 

13 Though the case is perhaps theoretically conceivable in which 
the increased capital would take such forms as to increase greatly 
the demand for land and increase rents but not wages. However, 
should the conclusions of the next chapter be accepted and applied, 
increase of capital would even in this extreme case be advantage- 
ous to wage earners- 



Wages and Population. 183 

high prices for them. The profits realized are 
gained by doing the public an in jury ^"^ and the 
methods followed should be effectively prohibited. 
There is no intention, of course, to deny the 
possibility that employees as well as employers 
may receive remuneration for, or remuneration 
which is enhanced by, anti-social activities. 

§ 2 

Influence of Physical and Influence of 
Value Productivity on Wages 

Enough has been said to make it clear that wages 
in any given line are measured by the marginal value 
productivity of labor in that line. Though the 
marginal physical productivity of labor remained 
at 300 bushels per year in agriculture, agricultural 
wages would nevertheless fall if the price of wheat 
per bushel and the purchasing power of wheat 
over other goods should fall. If, therefore, an in- 
creased per cent of the productive labor of the 
world should go into the raising of wheat, we should 
expect the remuneration of labor so engaged to fall, 
even though available land for the purpose was so 
unlimited and so equal in goodness that the num- 
ber of bushels produced per man occupied in 
wheat raising remained the same. 

If, in a country which is fairly well populated 
and which has reached, therefore, as to its ag- 
riculture, the point of diminishing returns, an 
increased number of persons in agriculture must 

1* Cf. the author's Principles of Commerce, New York (Macmll- 
lan) 1916, Part III, Chapter VII, §4. 



184 Earned and Unearned Incomes. 

bring a diminished proportionate physical prod- 
uct, this may not be equally true of all or, 
possibly, of any lines of manufacturing. England, 
for example, which, presumably, long since reached 
and passed the point of diminishing returns in all 
kinds of agriculture may still, with regard to much 
of its manufacturing, be in such a situation that 
more labor devoted to such manufacturing would 
yield a physical return in direct proportion or in 
nearly direct proportion to the increased labor so 
applied. Nevertheless, a sufficient increase in the 
number of persons engaged in these various lines 
of manufacturing might so decrease the marginal 
value product of their labor as to necessitate low 
wages. The increased supply of the goods thus 
produced would tend to lower the prices of these 
goods and hence to lower the returns which those 
engaged in producing the goods could hope to 
receive. We may conclude, therefore, that the 
reduction of per capita returns with increase of 
population in agriculture, tends towards lower 
wages even in manufacturing since, if it did not, 
an influx of persons into manufacturing would 
occur, lowering relatively the prices of manufac- 
tured goods and raising, relatively, the prices of 
agricultural products. 

We must not conclude, however, that the returns 
to labor are necessarily as low (or as high) in 
a manufacturing as in an agricultural country. 
Labor does not flow freely from one country to 
another. Furthermore, the people of the manufac- 
turing country may be highly efficient and they 
may be few in proportion to the demand for the 
goods they produce; while relative incapacity or 



Wages and Population. 185 

lack of resources for manufacturing may keep the 
people of the agricultural country from providing 
themselves or third and fourth countries with manu- 
factured goods. 

§ 3 
Comparative Wages in Different Labor Groups 

Something should be said regarding the relation 
of wages in one labor stratum to wages in another, 
e. g., the wages of skilled as compared with the 
wages of unskilled labor. It will, of course, be true 
that both the skilled and the unskilled workmen's 
wages will be fixed by the respective marginal 
value products of their labor. But the value of 
the goods produced by the skilled labor is relatively 
high just because such labor is relatively scarce. The 
higher wages of skilled labor or of intellectual 
labor requiring considerable training are really 
due, then, to the relatively limited amount of such 
labor available. 

The chief reason for the comparatively large 
amount of unskilled and the comparatively limited 
amount of skilled or highly trained labor (in rela- 
tion to the demand for it) is the cost of train- 
ing.^^ Unless the larger wages to be secured by 
training make up, in the average life time, the 
cost of this training plus interest, entrance into the 
skilled work will seem to many or to most, not 
worth while. Frequently the present deprivation 

15 Limitation of apprentices enforced by an interested labor group 
against would-be future competitors may also be an influence not 
without significance but, probably, of much less importance than 
the cause discussed in the text. 



186 Earned and Unearned Incomes. 

which must be suffered to meet the cost of training 
seems much greater than can be compensated by 
the larger later earnings to be so gained. To many, 
indeed, the cost of training is practically pro- 
hibitive.^^ They simply cannot make the invest- 
ment. Could funds be borrowed for this purpose 
at the current rate of interest charged on well- 
secured loans, the investment might pay much 
better than investments of other kinds. But the 
possibility that the borrower will become sick, or 
will die (though life insurance sometimes provides 
for this second contingency), or will simply fail 
to ''make good," makes the security uncertain and 
the funds hard to get. In these days of compulsory 
education up to 14 or 16 years of age, of night 
schools and of correspondence schools, possibilities 
exist for many who refuse to take advantage of 
them. But the opportunities of the poor boy are 
hardly roseate. To work daytimes and study 
nights is much harder than to be supported by 
high-salaried fathers whilst securing the training 
for a life work. For some, despite ambition, the 
physical strain is prohibitive. For all in such 
circumstances, the securing of the preparation 
essential to the higher grade of work means years 
of deprivation of rest or pleasure or both. 

The possibilities, however, are considerable for 
young men who are willing to defer marriage and 
the rearing of a family until after thirty. Indeed, 
marriage is not incompatible with self-accomplished 
success if children can be foregone until some 

16 Cf. Cairnes, Some Leading Principles of Political Economy, 
New York (Harper), 1874, PP- 65-68. 



Wages and Population. 187 

degree of preparation for more skillful work has 
been achieved. For both man and wife can then 
be remuneratively employed a part of the time 
and can make enough to pay for the leisure and 
expense necessary to train one or both the rest of 
the time. But to forego for so many years the 
satisfaction of one of the strongest animal instincts 
is, for most, too great a sacrifice. Unless the in- 
stinct can be satisfied and yet reproduction pre- 
vented, the opportunities of movement upward in 
the ranks of labor are likely to be much less 
availed of than might otherwise be the case. For 
various metaphysical, textual or conventional rea- 
sons, large masses of people believe the satisfaction 
of the sex instinct, when means are used to prevent 
conception, to be wrong. Obviously the utilitarian 
cannot jump to this conclusion. If consistent, he 
must test such means or practices by their effect on 
aggregate human happiness. He is bound to re- 
gard as desirable and as moral a policy or practice 
the tendency of which is to increase this happiness. 
The questions he would naturally ask regarding 
birth control are, first, whether it is desirable that 
the number of births in general or in certain class- 
es or in certain families should be limited, second, 
if such limitation is desirable, whether the potential 
parents are happier in satisfying the sex instinct 
and preventing conception by artificial means than 
they would be to deny themselves such satisfaction, 
and third, whether artificial prevention of concep- 
tion is necessarily injurious and, if so, whether it 
is injurious to such a degree as to offset the in- 
dividual and social advantages resulting from it. 
If it is answered that restriction of births is often 



188 Earned and Unearned Incomes. 

desirable, that the exercise of the sex instinct under 
such circumstances is a means of happiness and 
that the restrictive means may be so chosen as to 
have no injurious physiological effects of cor- 
responding consequence, or, perhaps, no injurious 
physiological effects at all, can the thoroughgoing 
utilitarian do otherwise than approve birth control? 
To the contention that general knowledge of the 
possibilities of birth control might result in an 
increase of promiscuous sex relations it may be 
replied that the earlier marriages thus made pos- 
sible for persons who can not afford to risk having 
large families early in life, would greatly diminish, 
for many, the temptation to promiscuity. It is 
not promiscuous sex relations, but marriage, that 
usually brings to the male the responsibility of 
supporting children. It would seem reasonably 
certain, therefore, that for him ability to postpone 
the having of children until easy circumstances 
make them desired would tell in favor of matrimony 
and against promiscuity. But the opponents of 
birth control may believe, not only that there 
are other objections to promiscuity than the likeli- 
hood of children being born for whom no fathers 
can be made responsible, but also that these other 
objections are not of a sort to impress very much 
other persons than themselves. The opponents of 
birth control, in their superior wisdom, see these 
objections, but the masses of humanity, not being 
competent to manage their own affairs except when 
kept ignorant, by force of law, of some lines of 
action they might else desire to follow, cannot see 
these other objections and so might take up 
promiscuity. If indeed there are no reasons for 



Wages and Population. 189 

objecting to promiscuity other than the danger that 
some children will have no definitely ascertainable 
fathers and if birth control removes this danger, 
then promiscuity must cease to be objectionable. 
But if there are other important objections to 
promiscuity it is entirely conceivable that the 
advocates of birth control and the masses generally 
are as capable of understanding them and being 
influenced by them as those to whom birth control 
is anathema. 

In another aspect than the one already discussed 
does the matter of birth control touch the compar- 
ative welfare of different economic classes. Pros- 
perous parents who can afford to give and do give 
their children the training necessary as prepara- 
tion for the more remunerative kinds of work 
have relatively few children ; while the poorer class 
of parents whose children can have little training 
have relatively large families. Not only would 
birth control among unskilled and slightly skilled 
wage earners enable them as individuals to fit 
their children for better jobs than their own; but 
also, even if they did not so educate their children 
it would tend to raise the wages of these children 
when they arrived at maturity since it would 
lessen the number of unskilled and slightly skilled 
wage earners. The knowledge required for birth 
control, although law prohibits its dissemination in 
the United States so that it is not easily available 
for the masses, is familiar to many if not most 
persons among the professional classes. They can 
and do regulate the number of children they shall 
have. It may be added that they do so in full 
consciousness of the fact that under present condi- 



190 Earned and Unearned Incomes 

tions there is a great gulf between professional 
earnings and the earnings of ordinary labor. They 
endeavor not to have more children than they can 
afford to educate for the professions or the higher 
positions in business. Were the birth rate among 
unskilled and slightly skilled wage earners lower, 
the number of children they could put into the 
higher grades of labor greater and, in any case, 
the number of children who must at maturity or 
sooner go into the lower grades of labor smaller, 
were the differences in wages of so-called high 
grade and so-called low grade labor thus reduced 
to a minimum, then it would not, perhaps, Dv.p,e^r 
so unfair as now, to parents of the professional and 
business enterpriser class, to have more children 
than they could afford to educate for that class. 
Aptitudes might have more to do, in all families, 
and financial obstacles less, with the choice of 
future work by the children. 

The subject of population and birth control is 
intimately related to the proper justification of 
child-labor prohibition. It has sometimes been 
objected by opponents of child-labor laws that to 
prohibit the labor of children may so limit the 
incomes of some families as to deprive the children 
themselves of proper food. The argument runs 
to the effect, therefore, that the prohibition of 
child labor may be more cruel than the permitting 
of it. The families affected need the food, the 
clothing, etc., which the children earn. Particularly 
are the earnings of the children needed when the 
number of children is large so that the father 
cannot properly support all. Superficially this argu- 
ment may be plausible. But the fundamental 



Wages and Population 191 

consideration which it overlooks is that permitting 
child labor makes families large. To many a 
father willing to put his children to work at an 
early age these children have become an economic 
advantage. He has lived in comfort, in semi-idle- 
ness, perhaps in drunkenness, off of the earnings 
of their unhappy child efforts. To plead the 
necessity of child labor as an aid in the support of 
such families, is to be plead the necessity, as a 
palliative, of the very cause (in large part) of the 
evil. If child labor is sternly prohibited by law, the 
prohibition has the advantage of putting squarely 
upon parents the responsibility of supporting their 
children and of discouraging their having more 
children than they can comfortably support. Such 
a policy, coupled with unforbidden dissemination 
of methods of birth control, would go far to prevent 
multiplication of numbers in the now low-paid 
labor groups, with the consequent low wages, poor 
living and absence of opportunity. If the economic 
well-being of an entire community is to be main- 
tained at a high level, perhaps nothing is so im- 
portant as to establish the principle that those 
who bring children into the world must provide 
these children with a childhood not wholly devoid 
of opportunity and of happiness, and therefore, by 
implication, that they must not have more children 
than can be so provided. 



192 Earned and Unearned Incomes 

§ 4 
A Side Light on the Interest Problem 

The chapters on interest^^ have, it is hoped, made 
it clear that interest, provided the capital for the 
use of which it is paid is not used in anti-social 
ways, is earned in just the same sense as are, with 
a like proviso, the wages of labor. The waiting 
yields a service to the community worth as much 
as the interest received, as truly as the labor 
yields a service worth as much as the wages re- 
ceived. The person who works and saves is, to the 
extent that this saving operates in aid of production, 
just as good a servant of the general welfare as the 
person who works more but saves less. Contrary to 
the view of orthodox socialism, interest as such is no 
more robbery or exploitation than wages. Nor 
would there probably have arisen so considerable an 
opposition to it if its enjoyment were widely distrib- 
uted among the masses in any such degree as the 
enjoyment of wages. Interest appears to lack justi- 
fication to many because it seems to be connected 
with a narrow class interest. 

At just this point we need to recur to our 
discussion of comparative birth rates. The reason 
why large classes of the population cannot enjoy 
interest is because their wages are low and because 
their families are large. Their wages are low 
because they have many competitors in their 
unskilled work and they have many competitors 
because the previous generation of unskilled labor- 
ers had relatively large families and could help 

17 Chapters III and IV. 



Wages and Population 193 

few of their children into better paying kinds of 
labor. Fewer children in this class of the popula- 
tion would make accumulation of capital possible 
to them in just the same way that it would make 
possible the investment of larger sums in the 
industrial training of their children. And fewer 
children among wage earners of this class would 
mean, in a generation, not only smaller expenses 
for the bare necessities of life, but also larger 
wages from which to make savings. If we can, 
eventually, stamp out exploitation and if we can^ 
at the same time, intelligently control population 
changes, there need be no reason why any family 
may not have some accumulated capital and receive 
an interest income along with its labor income 
and, at the same time, labor incomes may reason- 
ably be expected to become less unequal than now. 
If, with the way of hope thus open to each family, 
some refuse to profit by it, we can hardly conclude 
that posterity will be benefited either in stimulus 
to ambition or in the greater inheritance of desir- 
able traits, by a policy which would take a part 
of the earnings .of the ambitious, the capable, the 
industrious, the far-sighted and the saving, in 
order to increase the already too numerous progeny 
of those who possess none or few of these virtues. 
There is no intention here, to suggest that 
interest or, for that matter, wages, constitutes an 
income of a peculiarly sacred sort so as, for 
example, to be an unfit subject for taxation. 
Government, which serves all of us, needs funds 
to do so and, if no better and adequate sources of 
revenue can he found, it may properly enough tajc 



194 Earned and Unearned Incomes 

both interest and wages.^^ But there is the in- 
tention to emphasize the similarity of interest and 
wages so far as the giving by the recipient of a 
quid pro quo is concerned, and to suggest that 
wider and unimpeded spread of knowledge and 
ideals, increased emphasis on parental responsibil- 
ity, and, along with these things, the effective 
prohibition of all forms of exploitation, may do 
much that so-called corrective taxation has been 
called upon by its advocates to do, and may do it 
better and with less of offsetting evil. 

§ 5 
General Wages and Population 

Even if it were possible to get the most desirable 
proportion of the population in each kind of work 
and in each class or stratum of labor, this would 
not alone solve the population problem; population 
as a ivhole must be reasonably limited. Invention 
may for a while go on so rapidly that a larger 
population can be better fed than a smaller one 
was before. Inventions and discoveries of some 
sorts make it desirable to devote more time to 
less land, for example, the discovery that spraying 
trees leads to their yielding of more, larger ana 
better fruit. Inventions and discoveries of such 
a kind may mean that a larger population can 
secure as much per capita as, with the same 
degree of skill and knowledge, a smaller popula- 

18 Least of all can any class able to pay largely, fairly claim ex- 
emption when the nation is in peril from foreign foes and when 
lives must be sacrificed as well as incomes. A source or sources of 
public revenues ordinarily ideal ma^ then prove insufficient, 



Wages and Population 195 

tion could secure. But not all inventions and 
discoveries work to this effect. Some, for example 
the invention of much of agricultural machinery, 
enable fewer people effectively to utilize larger 
areas. The consequence of such inventions is that 
a large population is relatively superfluous, that 
the additional men add relatively little to the 
total product of industry, that the point of dimin- 
ishing returns is passed when with the same 
population and less advance in the mechanic arts it 
would not be reached. This conclusion is not in- 
consistent with the fact that the inventions in 
question may enable the existing population to be 
supported in greater average comfort than before.^^ 
Our conclusion is simply that the gain from those 
inventions which enable few people to utilize larger 
areas would often be greater per capita were pop- 
ulation smaller. It is not necessary, therefore, 
to show that increasing population always involves 
increase of poverty, to make reasonable an opposi- 
tion to the growth of numbers. If it be merely 
shown that per capita wealth is likely not to 
increase as rapidly or as far with development of 
the arts of life, in the case of a larger population 
as in the case of a smaller one, the desirability 
of the smaller population may be sufficiently es- 
tablished. 

But what is our standard or test of an ideal 
population? Would we prefer that there should 

.!» Though there may be effects on distribution such that land- 
owners as such derive most or all of the gain, or more than the 
gain. See Henry George, Progress and Poverty, Book IV, Chapter 
III. 



196 Earned and Unearned Incomes. 

be in the United States 75 million very happy 
persons, 150 million moderately happy persons, 
or 300 million persons whose average happiness is 
slightly better than zero? Is the greatest aggregate 
surplus of pleasure over pain our desideratum or 
is the greatest per capita surplus of pleasure the 
thing to be aimed at? The former would probably 
be realized with a density of population somewhat 
greater and a per capita income somewhat less 
than the latter. If we suppose that the greatest 
per capita happiness is the thing to be sought, it 
is likely that the desirable degree of density of 
population is such as, on a given stage of techno- 
logical development, will make for the largest 
possible per capita product with the smallest per 
capita effort.^^ But in any case and according to 
any reasonable test the ideal population is almost 
certainly not the maximum possible population. 
It is not to be expected that the ideal population 
will ever be exactly attained for the world as a 
whole or for any part of the world. If the number 
of children to a family comes to be a matter of 
individual judgment and choice, with free diffusion 
of knowledge as to how the desired number may 
be made the actual number, population will probably 
tend to adjust itself in the direction of the greatest 
per capita happiness. It is to the interest of the 
individual and of the family that individual well- 
being and family well-being should become the 

20 Allowance must be made for the fact that what is the ideal 
population may change as knowledge of the arts of life changes. 
The ideal population in this generation may not be the population 
which is best for the men and women of this generation but may be 
one which can easily grow into or decline into the population which 
is best for later generatiotxs. 



Wages and Population. 197 

greatest possible. It is not unreasonable to suppose 
that the greatest aggregate net happiness would 
also be greater were births so restricted as to 
avoid some of the abject poverty which now results 
from too rapid increase in certain families and 
classes. 

§ 6 

Immigration and Wages 

Even if the people of a country adopt a rational 
attitude toward the population problem, the possi- 
bility of overpopulation from immigration has 
still to be faced. Thus, a policy of limiting off- 
spring among the present population in the United 
States in the hope that the next generation would 
not find competition too severe, might have its 
intended results negatived by an inflow of labor 
from other countries. The children of races which 
had applied no such limitation might come in to 
inherit, in part, the land whose small population 
the intelligence of its people had made possible, 
and to decrease largely the gain resulting from 
such intelligence. Immigration may offer a contin- 
uing prospect of gain to the landowners of a 
country but it holds out no general promise of 
gain to native wage earners.^^ 

§ 7 

Summary 

We have seen that wages are fixed by demand 
and supply at such a point that wage-earners tend 

21 Cf. the author's Principles of Commerce, New York (Macmil- 
lan), 1916, Part II, Chapter VI, § 3, footnote. 



198 Earned and Unearned Incomes. 

to receive the marginal value product of their 
labor. The value of the goods produced by some 
classes of labor is low and the wages of the labor- 
ers are low simply because these laborers are 
numerous and products of their labor relatively 
too plentiful. These classes of workers have so 
little surplus spending power that they can not 
usually afford the cost of raising their children 
out of their own class. Nor do they sufficiently 
limit the number of their children, on the average, 
to reduce the labor supply in their own class in 
the next generation and so make necessary higher 
wages for that class. Limitation of size of families 
would help them to aid their children more effect- 
ively to prepare for other work and, even if it 
did not, would eventually raise the wages for the 
work in question. A better relative adjustment 
of numbers in different labor groups would also 
make possible a more widespread accumulation of 
capital. Interest is earned as surely as wages are 
earned, if the test is the giving of a quid pro quo 
by the recipient. But interest is not so generally 
enjoyed and hence is looked on by the masses with 
less favor. The ideal perhaps is that every family 
should receive an interest income as well as a 
wage income. Population in general needs to be 
limited as well as population in special groups, 
in order that average prosperity and happiness 
may be high. This may necessitate for low birth 
rate countries restrictions on the too free immigra- 
tion from countries whose inhabitants multiply 
with little regard to economic consequences. 



CHAPTER VI 

THE RENT OF LAND AND ITS TAXATION 

§ 1 
Land Rent as a Marginal Product of Land 

In the previous chapter^ we had occasion to 
suppose the existence of a piece of land on which 
the labor of five men working with the aid of 
improvements and equipment worth $5,000, pro- 
duced a yearly product above repair and deprecia- 
tion costs, of $2,200. Of this $2,200, wages consti- 
tuted $1,500, interest (at 8 per cent.) $400, and 
$300 a year remained as rent. This $300 measures, 
roughly, the amount of rent the owner could 
secure from a tenant. It is the surplus produced 
on the land, above the remuneration of the labor 
and waiting used. But we have seen that the 
remuneration of waiting, the interest on capital, 
is fixed by demand and supply at a point where it 
equals the marginal productivity of waiting.^ We 
have likewise seen that the remuneration of labor 
is fixed by demand and supply at a point where 
it equals the marginal product of labor.^ Hence, 
to say that a piece of land yields per year c 
surplus of $300 over interest to waiting and wages 
of labor is to say that it yields a surplus of $300 
above the marginal product of such waiting and 

1 Chapter V, § i. 

2 Chapter IV. 

3 Chapter V, § i. 

(199) 



200 Earned and Unearned Itstcomes 

labor. Let us suppose this particular piece of 
land to be non-existent. Then the labor and 
capital applied upon it must needs be applied on 
poorer or less well situated land not previously 
used, or this labor and capital must be applied to 
using more intensively land already in use. Applied 
in either of these ways, such labor and capital 
would produce $300 less than could be produced 
if the labor and capital were applied to the 
$2,200 yielding land. In other words, the $300 
is the product of this particular piece of unimprov- 
ed land in the sense that the existence and use of 
this piece of land makes it possible for a product 
$300 larger* to be secured with no more labor 
and waiting, simply because the land resources to 
which the labor and waiting are applied are that 
much better than the margin at which the labor 
and waiting in question must otherwise be 
applied. But although $300 may thus be regarded 
as a contribution of the land to production, it is not 
on that account to be regarded as a contribution of 
the land-owner to production. 

It is to be emphasized that the rent of city 
land is determined in just the same way as the 
rent of land in the country. The well-located 
merchant derives a larger return from his business 

* By way of qualification it may be said that this differential is 
not fixed but is greater for some potential users of the land than 
for others. Some users may be able to gain from the use of a 
piece of superior land much more than they have to pay. To others, 
the differential is less than the rent and they will presumably use 
inferior land. The marginal productivity of the land is its pro- 
ductivity to the user who is just induced to hire it and who, if 
rent were greater, would have to resort to poorer land. 



Rent of Land and Its Taxation 201 

as a retailer or a jobber by virtue of his superior 
situation. So, also, the manufacturer whose busi- 
ness is wisely located in relation to sources of 
power and to shipping facilities derives from such 
a location advantages for which he may be willing, 
if necessary, to pay a high rent and for which, if 
the desired location is equally advantageous to 
others, he will have to pay such a rent. In the 
case of either country or city land it is here 
intended to regard as land rent only the amount 
which is the marginal product of the land as 
such. Interest on the cost of improvements, 
whether swamp draining and fertilizing in the 
case of farm land or filling and leveling in the 
case of city land, is not properly a part of the 
rent of land but is a return on capital investment. 
The amount of rent which landowners can get 
for the use of their land appears to be pretty 
definitely fixed by the conditions of demand and 
supply. Attention is commonly called, by econom- 
ists, to the fact that a tax on land rent can not be 
shifted. The owner of the land cannot, when 
a tax is levied, get any more rent. The tax does 
not increase the marginal product of the land. It 
does not decrease the marginal product of waiting 
or the marginal product of labor. It can not make 
interest lower or wages lower. It cannot, there- 
fore, increase the difference between the total 
product of the land and the amount going to 
capitalists and wage earners. It does not make 
land space any scarcer. The tax-paying land- 
owner can even less afford to keep his land idle 
than the landowner who is untaxed. It does not 



202 Earned and Unearned Incomes. 

decrease the quantity of goods produced on the 
land and does not increase prices. It simply 
leaves the landowner with a smaller income by the 
amount of the tax substraction. A tax on interest 
might diminish saving and make interest, eventual- 
ly, higher. A tax on wages, especially if heavy, 
might diminish population and so make wages, in 
a later generation, larger.^ But a tax on rent can 
have no effect other than to diminish the amount 
of revenue received by landowners and give this 
revenue to the general public.^ It should be said, 
however, by way of qualification, that when the 
so-called ''rent" results not chiefly from a favor- 
able situation or other conditions independent of 
the owner's labor but in part from a fertility 
which has to be maintained by the owner, some 
shifting may take place. (Return on improve- 
ments due to labor, is properly interest on capital.) 
But a tax upon the situation rent or value of 

5 This suggests the Physiocratic doctrine that all taxes must in- 
evitably be borne by the landed proprietors of a country, through 
diminished population and lower rents. The conclusion may be 
(and may not be) largely true, if we include owners of urban, etc., 
as well as agricultural land, as the Physiocrats did not. But a tax 
on wages thus shifted to landowners will fall upon them in very 
different proportions than a direct tax levied as a percentage of 
rental value. The former will fall much more heavily in proportion 
on the owners of near-marginal land and the latter will fall with 
equal proportionate weight on the owners of superior land. 

6 To appropriate rent in taxation provided land is used for some 
purposes but not if it is used for other purposes, would discourage 
the former kinds of uses and encourage the latter. See the author's 
Principles of Commerce, New York (Macmillan), 1916, Part III, 
Chapter III, § 4. Such a tax must, therefore, result in a degree 
of shifting. 



Rent of Land and Its Taxation 203 

land, or upon the rental value resulting from any 
natural and indestructible advantages, falls upon 
the owner and upon no one else. 

§ 2 

Land Rent Versus Capital Interest 

An examination of the justice of special land- 
value taxation may advantageously begin with a 
brief consideration of the difference between rent 
and interest. The distinction between them has 
been elaborated elsewhere^ and need not, perhaps, 
be long dwelt upon here. It is sometimes said that 
the rent of land is no less interest than the return 
on other capital, since the return on land can be 
viewed as a given percentage on a given valuation, 
while on the other hand, the interest on other 
capital can be viewed as an absolute amount in 
dollars per machine or factory, just as land rent 
is viewed as so many dollars per building lot or 
per acre a year.^ But more fundamentally there 
is a difference, despite the superficial resemblance, 
between situation rent and capital interest. The 
return on land should be looked at as an absolute 
amount measured and determined by the surplus 
over production on the extensive or intensive mar- 
gin. It is not determined by the value of the land. 
Neither has the value of land as such, i. e., its situa- 
tion value apart from improvements, any relation 
to any cost of production, since the land was not 

7 Chapter IV, §§3 and 5. 

s This view seems to be presented in Fisher, The Nature of Capi- 
tal and Income, New York (Macmillan), 1906, pp. 184-188. 



204 Earned and Unearned Incomes. 

humanly produced. On the contrary, the value 
of the land can be arrived at only by discounting 
its expected future rents or returns at some 
previously found rate of interest. Thus, a piece of 
land which would yield $5,000 per year net rent 
(above taxes, wages of labor employed, interest 
on the capital invested in buildings and other 
improvements, and insurance) would be worth, if 
interest were 5 per cent, $100,000. Were the 
current rate 10 per cent, such a piece of land 
would be worth but $50,000. 

With equipment of the producible and reproduci- 
ble kind, however, the relation between capital 
and income value is not the simple one above 
outlined. The value of such capital, though not 
unaffected by the value of its expected services, 
is very directly related to the cost of its production. 
Buildings of a type costing $5,000 each will hardly 
be put up to sell for much less, as a rule, by the 
builders. Nor, so long as the alternative is open 
to him of supervising the construction of a 
similar building, will a possible buyer care to pay 
a great deal more.^ The value of a building is 
determined then, in large part, by the expenses, 
such as wages, of producing the materials and of 
putting it up; and these wages are determined, in 
the last analysis, by the existence of alternative 
lines of activity open to the wage-earners, while 
the other costs are determined by the alternative 

9 If he purchases a building already constructed he pays, in its 
cost, for the supervision of its construction. 



Rent of Land and Its Taxation 205 

uses to which the land or capital which must be 
used in producing the materials might be put.^*^ 
Since the value of produced and reproducible 
capital is thus in large part fixed directly by its cost 
of production, the assertion that interest is in 
large part determined by the rate of productivity 
of capital does not involve reasoning in a circle. 
Interest is 5 per cent because, for one and perhaps 
the most important reason, capital worth $10,000 
will produce an annual net income of $500. It 
therefore appears, to sum up our conclusions thus 
far, that the value of produced capital depends in 
a considerable degree on cost of production, that 
the ratio between the value of capital and its 
income is an important factor in determining 
the general long-run rate of interest, and that 
this rate of interest is an essential element in the 
valuation of land. 

§ 3 

Land Rent as an Unearned Income 

It is but a short step to the conclusion that the 
accumulators of produced capital may — and in 
many cases doubtless do — add to the volume of the 
annual aggregate income of society as much as 
they take out of this income in interest; while the 
owners of land, as such, contribute no service in 
return for their income. Whereas, in the case of 
produced capital, the public (except in certain 
cases, numerous enough no doubt, where the 

10 Cf. Davenport, Economics of Enterprise, New York (Macmil- 
lan) 1913, pp. 6i-66. 



206 Earned and Unearned Incomes. 

capital is wastefully or injuriously used) pays 
the owner for a service which, without his saving 
(or the saving of someone whose right to pay- 
ment has been transferred to him), would not 
have been enjoyed, in the case of land the pay- 
ment is made for a benefit which is dependent on 
no individual's saving or effort and a benefit for 
which, therefore, no individual is responsible. In 
the one case the community pays for a service 
which is actually rendered to it. In the other case 
it pays people who have, in the capacity in which 
they are paid, rendered no service.^^ 

To avoid any possible misunderstanding, let it be 
emphasized that land rent as here defined does not 

11 The view presented so consistently in this book that incomes 
received not in payment for service rendered lack social justification 
will, of course, not be accepted by the Junker type of mind. More 
or less plausible arguments may again be advanced as they have 
often been before, in favor of incomes to privileged classes. It 
will be alleged that members of these classes, not having to worry 
about their livelihood, will become efficient officers of state, scholars 
devoted to research, and, in other ways, profitable social servants. 
To the argument that if a class is to be supported without definite 
regard to a special service for which their income is received, in 
order that such results may accrue, the public might select in a 
better way the individuals who should make up this class, it will 
doubtless be replied that, in practice, the public will not select in 
any such manner as to give equally good results. Or the sup- 
porters of a privileged aristocracy may go a step farther and de- 
fend its existence, not by virtue of any alleged superior social serv- 
ice, but as being good in itself, as a class for the good of which 
other classes exist, as constituting "the backbone of the state." To 
one who accepts either view above outlined, no argument against 
exploitation will be convincing, especially if the exploitation is of 
an ancient sort and has the prescriptive sanction of long usage, as 
is the case with land rent. 



Rent of Land and Its Taxation 207 

mean merely the sum paid by a tenant to an 
owner, for the use of land, but equally the 
amount received by the person who himself uses 
his own land, in excess of wages for his labor 
and interest on his capital. This rent comes to 
him in money when he sells the goods or services 
which the land produces. He is paid, thus, by 
others, for benefits which not he but the land 
renders. The community, in buying from him, 
pays him for more than the service he and his 
"waiting" render them. 

But, it may be said, at least many of the present 
landowners are persons who have made their 
savings from what they have earned and have 
chosen to invest their savings in land rather than 
elsewhere. Have they not, in their savings, given 
the community as much value as they draw in 
rent? The answer may well be that they have 
given, to that part of the community from whom 
their rent income is derived, nothing whatever. 
If A, who has saved $10,000, uses it to buy a 
piece of land from B, he is merely paying B for 
the privilege, previously enjoyed by B, of receiv- 
ing rent from others for the use of something 
that neither he nor any other individual produced 
and the use of which would be equally available 
had no owner or purchaser of land ever been 
born. In turn, B has now the $10,000 of accumu- 
lations and it is quite possible that he may use 
it in some way that will increase the annual 
product of industry. If so, the community, or 
some members of the community, will come to be 
paying B, in interest on capital, for services which. 



208 Earned and Unearned Incomes 

without A's saving, would not have been available, 
while they will be paying A, in rent, for benefits 
from the use of land, which are not due to any 
individual's work or savings. If, before, the 
community was paying the landowner B a rent 
while getting no service that could fairly be 
regarded as coming from him, now it is making 
payments to both A and B, as rent and interest 
respectively, and receiving services in return from 
only one. If, before, B the landowner was a 
pensioner to whom the community gave something 
for nothing, now A has become the pensioner, 
having bought out B,* and is receiving, from the 
rest of the community, something for nothing. For 
it should be clearly evident that the $10,000 paid 
to B for the land is not a service rendered to C, 
D, or E, who are the persons that have to pay 
A for the use of the land. Yet much of emphasis 
is commonly directed to the assertion that the 
land-using part of the community ought to pay 
rent to landowners because these landowners have 
in many cases paid previous landowners for the 
land and despite the fact that none of the land- 
owners in the series can be said to have rendered 
any service to those from whom they collect rent 
payment. In other words, it is asserted that C, 
D, and E ought to be obliged to pay A for no 
service rendered by him or by anyone, simply 
because A previously paid $10,000, not to C or D 
or E, but to B. Is such a doctrine good utilitarian- 
ism? Is its application good social policy? 



Rent of Land and Its Taxation 209 

§ 4 

Improvements by Special Assessments and the 
Right of Landowners to a Rental Return 

Nevertheless, to assert that in practice the land- 
owner, as such, never performs any service for 
which he is entitled to a return in payment for 
the use of his land is going too far. If he is 
entitled to nothing else, he is usually entitled to a 
return on the cost, to him, of improvements (such 
as cutting through and paving streets) met by 
special assessments. These assessments are custom- 
arily made on all owners of land where a street is 
to be put through or paved, on the theory that 
they derive a special benefit from the improvement, 
a theory which is generally in accord with the facts. 
It would seem that there is much the same 
reason for the owners of land which is, in effect, 
improved by such expenditures, to meet them as 
there is for farmers to pay the cost of fencing and 
manuring their own land. 

That the benefit of this street building (as of 
social growth) goes to the landowner as such, and 
not to the owner of buildings on the land, should 
become apparent when it is realized that a build- 
ing, apart from its situation, can hardly go much 
above the cost of putting up another like it. 
Suppose two building lots side by side, each 
worth $2,000. On one, a $5,000 house is put. The 
other stands vacant. If the building of a street 
or the growth of the community makes the combined 
house and lot worth $9,000, is not the added $2,000 
an increase in the value of the land? If there is no 

14 



210 Earned and Unearned Incomes 

change in the cost of putting up such a house, will 
not the adjoining land (on which an exactly sim- 
ilar house can be built for $5,000, to sell, with the 
lot, for $9,000) immediately come to be worth 
$4,000? A house or other building unwisely located 
where it cannot be used may come to have less 
value than its cost, by the necessary expense of 
moving it, or, if it is not movable to a desirable 
locality, by an indefinite amount. But a house, 
as such, can hardly increase in value much above 
its cost of duplication. Analysis seems to show 
that the increase inheres in the site. 

If, then, on the basis of this fact, the owner of 
land is compelled to bear the cost, or most of the 
cost, of the improvements made, it seems but rea- 
sonable that he should be allowed to enjoy some 
return on his investment in the expense of paving 
or other improvement, if any such return is forth- 
coming. This does not mean that he is entitled to 
secure all the value that results from social growth, 
or, perhaps, any of the value so resulting, but it 
may mean that he should be regarded as the owner 
of^ and is entitled to interest on, the difference be- 
tween what the value of the land in question would 
be to a prospective purchaser by whom the costs 
of improvement had still to be met, and the value 
to a purchaser after such improvements have been 
made. In short, the investor is entitled to a 
return — if the land can ever be made to yield it — 
on the expense to him of the special assessments. 

It seems clear enough to the writer that a not 
very excessive rate on such expenditures for street- 
making, etc., will compensate owners on the aver- 



Rent of Land and Its Taxation 211 

age for any risks that their land may, in certain 
contingencies of population-shifting, yield less than 
an average return on such expenses. If, however, 
a group of lot-owners take steps to have a street 
cut through long before there is need of it and 
therefore find that a return on this cost cannot for 
some time be had, it does not follow that these 
owners are entitled to get, out of the increased 
value which later may result from social growth, 
all the interest lost during the interval of waiting. 
That the value of city land usually includes more 
than can be accounted for by the expense of such 
improvements is evident if we call to mind the value 
of well-situated land where such local improvements 
have not yet been made. A piece of land in a 
great city, situated where the building of a street 
was contemplated but not begun, might well be 
less valuable by only about the cost of the necessary 
assessments than if the street were there. With- 
out doubt it is sometimes true that improvements 
such as street construction start the fashion of 
living in a given section of a city and so bring up 
the value of sites there by far more than the cost 
of the improvements. But it is also true that the 
outward pressure of population or the building of 
a railroad or trolley line gives value to the un- 
improved land in the absence of streets, and makes 
the putting through of the streets worth while. 
In this latter case the causal influence runs the 
opposite way. It is the conditions leading to 
increased value, and the contingent possibility of 
deriving from the land an income previously not 
obtainable even if improvements had been made, 
that give rise to the street-cutting movement. 



212 Earned and Unearned Incomes 

Our conclusion seems to be that owners of 
land are entitled to a return on their investments 
in improvements, such as special assessments for 
cutting streets, in the same sense and to the 
same degree that they are entitled to a return 
on the cost of building houses or factories; that, 
however, they are no more entitled to a socially 
guaranteed return in the one case than in the 
other ;^2 and that there is no reason why they 
should be allowed more than enough, on the basis 
of such expenditures, to make the expenditures 
worth while. It does not follow that the sums 
required as special assessments or purposely in- 
vested by land speculators in street building, etc., 
are not fairly subject to tax in the same way as 
any property is subject to tax, but only that 
whatever reasons there may be for special taxa- 
tion of land values in general do not apply 
to the part of land values clearly due to such 
investments any more than they apply to the 
part of farm land values due to the owners' 
expenditures in fertilization. 

§ 5 

Other Services of City Landowners 

Are there any other expenses met or services per- 
formed by the city landowner which are to be 
regarded from the viewpoint of the land-value- 
taxation philosophy as entitling him to some ex- 
emptions? Does the landlord, for instance, per- 

12 Except as the community compels them to make improvements 
at their expense in advance of their own desire to do so. 



Rent of Land and Its Taxation 213 

form a service worthy of a share of economic rent 
by ^'managing" the land? Is the joint activity of 
landowners in a given section, in determining the 
class or race of tenants who may live in such a 
section, or attending to other matters of common in- 
terest, a service entitling them to the enjoyment of 
rent? Some of this activity or attention is needed 
only when the land is used for residential purposes, 
and perhaps might be given, under some arrange- 
ment for a percentage consent in favor of new 
residents, by tenants instead of by landowners as 
such, or, as is sometimes the case in a limited 
degree, by municipal ordinance. The desired pro- 
tection of tenants in the matter of neighbors is 
but inadequately given when even two or three 
landlords, by departing from a general understand- 
ing, choose, for a profit, to admit undesirables as 
tenants or purchasers. Municipal protection 
might not, in a democratic community, be much 
better, but it probably would not be much worse. 
At any rate, any service of this sort yielded by 
landowners does not entitle them to more than 
a very small fraction of the annual rent of the 
land. To say that it is worth all the rent in 
every case is to say that it is worth much more 
in a metropolis than in a small town. And to 
say that all the rent is earned by such service is 
to say that the cost and trouble of rendering the 
service so offsets the rent as to make the value 
of the land (the amount that a purchaser would 
pay for the future enjoyment of the rent) zero. 

Another view is that the rent of land, instead 
of being, aside from interest on special assess- 



214 Earned and Unearned Incomes. 

merits, altogether an unearned increment, is partly 
a compensation for risk and a stimulus to seek 
out and bring into use desirable locations. In such 
a view, it might be argued that the real estate 
dealers who develop a new section of a city or a 
city suburb for residential purposes risk getting but 
an inadequate return; or the capital put into im- 
provements may be, if the new section proves 
to be wholly unpopular, entirely lost. Must there 
be a chance for a corresponding gain of the so- 
called unearned-increment variety in order that 
the improvements desired shall be made?^^ And if 
the possibility of surplus gain needs to be kept 
open to the land speculator, must this gain include 
all the rental value of the land for all future time? 
Is the fact that a given speculator foresaw, earlier 
than others, the possibility of developing certain 
sites, and thus hastened the flow of business or 
population to them, a reason why later generations 
of business people or of residents, to whom the 
early bringing into use of the land is no advantage, 
should have to pay him for the privilege of working 
or living on it? Of what service is such earlier 
development to these later generations, that they 
should have to pay an extra rent for the space 
used, in order to compensate, for an early risk of 
loss, landowners or the descendents of landowners 
who took risk by, possibly, premature building in 
a new section? So long as this section is now 
built up and available for business or residence, 
its having been built long before their use of it 
is probably of no advantage to present users. If 

13 Cf. Hadley, Economics, New York (Putnam), 1896, pp. 287-291. 



Rent of Land and Its Taxation 215 

these present users must pay more in consequence 
of such early development, the landowner is pre- 
sumably receiving payment from persons to whom 
neither he nor his predecessors have, as land- 
owners, rendered a corresponding service. 

In the case of inventions and patents, we limit 
the time during which the inventor is to enjoy 
a special profit on his idea, our philosophy being — 
partly, at least — ^that after a few years the general 
progress of knowledge would be likely to bring 
the essential idea involved to someone else or to 
several, and that the general public or that part 
of the public using the invention cannot be re- 
garded as perpetually indebted to the patentee. 
May not the discovering of, and the calling of the 
community's attention to, the value of new sites 
be a service of this limited kind? Can it be sup- 
posed that the residents of a city would forever, 
and despite increase of numbers, be indifferent to 
the advantages of living in "Hillcrest," '^River- 
view," "Countryside," or "Eastville"? For how 
many generations must the public pay the descend- 
ants of, or the purchasers of land from, those who 
first emphasized or advertised the advantages of 
these sections for the service of thus advertising 
them? It is, indeed, quite possible that the land 
speculators who first, by their advertising, induced 
population to move into a new section, have some- 
times performed a disservice rather than a service, 
by unduly hastening a movement which would have 
normally come somewhat later. 

Another point sometimes emphasized in the 
case of patents is that a limited period of special 



216 Earned and Unearned Incomes. 

profit is enough to induce the invention and its 
exploitation. It is unnecessary, therefore, to 
make the public pay this excess profit forever. 
May not the same conclusion apply in the case of the 
service of landowners in calling attention to the ad- 
vantages of special sites? 

Even if we should decide that this particular 
kind of service was of no value and that we 
did not wish population or business location to 
be affected by the activities of land speculators, 
and even if, therefore, we allowed no part of 
the rental value of land to go into private hands 
to pay for such services, there would need to be 
no fear that houses and other structures would 
not be built. Obviously, a certain intensity of 
demand and willingness to pay rent for houses, etc., 
on the part of tenants, would yield a sufficient 
average return on the cost of building to make 
investors willing to take the risk of building in 
places where there was reasonable probability 
of the use of the houses, and this without any 
prospect of realization of situation rent as an 
offset to possibilities of loss. 

While we are on this general topic, one point 
should be particularly emphasized, viz., that fore- 
sight, purely as such, deserves nothing whatever. 
The man who, foreseeing a rise in certain land 
values from a probable increase in, or shift of, 
population, puts himself in a strategic position 
to profit by it, is not thereby rendering any 
service to those from whom he derives return. 
Foresight used to give a service may earn remu- 
neration. Foresight used to get something for 



Rent of Land and Its Taxation 217 

nothing seems hardly deserving of any special 
protection. 

§ 6 

The Increment of Land Values in Relation to the 
Settlement of the American West 

The expectation of an increase of land values, 
considered as an inducement to bringing new 
land into use, has sometimes been brought up in 
connection v^ith the settlement of the West. It 
has been asserted, for example, that the lure of 
the "unearned increment" v^as instrumental in 
inducing the settlement of the West.^* It has 
also been argued, in the same connection, that the 
stimulus to settlement of the West and its earlier 
settlement because of this prospect of an increas- 
ing value of the land, benefited not only the set- 
tlers, but also those who remained East, and that, 
therefore, the unearned increment was ''diffused" 
throughout the country.^^ Many have doubtless 
drawn from this contention the conclusion that 
the descendants of the early settlers in the 
West are clearly entitled to any increase that 
may have come to the value of their land. The 
argument regarding the diffusion of the increment 
is based upon the belief that the prospect of 
rising land values, by inducing a movement of 
the labor supply westward and its settlement upon 
the farms, prevented the labor congestion in the 

14 See J. B. Clark, The Distribution of Wealth, New York (Mac- 
millan), 1899, pp. 85-87. 

15 Ibid. 



218 Earned and Unearned Incomes 

East, in the cities, and even in the agricultural 
West from being as great as it might otherwise 
have become. Hence, it can be argued, the settle- 
ment of the West prevented the marginal product 
of labor from being so small and wages from 
being so low, in the East and elsewhere, as might 
otherwise have been the case. 

But may we not, in some degree, question the 
conclusion that an unearned increment, or any 
substantial amount of it, was necessary to get 
the West settled? After all, relatively few of 
the settlers were fortunate enough to take up 
land which afterward became part of the sites 
of cities and it is probable that most of them 
did not seriously expect such fortune. May we 
not conclude that, for the most part, they might 
have been willing, for the possibility of enjoying 
homes where the marginal product of their labor 
gave promise of being high to go and take up new 
land even though the value of the bare land, as 
such, could not be expected greatly to increase? 

If not, however, if, on the contrary, the pros- 
pect of an increasing land value was an essential 
part of the invitation of the West, then the ques- 
tion arises whether settlement was hastened, to 
the temporary economic loss of those who went 
first and to the later loss (through rent payments) 
of those who followed, and whether a more grad- 
ual spreading of population westward, when 
a real need rather than an artificial inducement 



Rent of Land and Its Taxation 219 

began to operate, would not have been economi- 
cally better.^^ 

As to the question whether the early comers or 
their descendents are entitled to rent compensation 
for being earliest because of any service that they 
thus rendered, we must bear in mind that any such 
compensation, under our present land system, 
does not come from those easterners whose wages 
are conceivably higher because of the drawing 
off of surplus population to the West. Nor will 
it probably come, for the most part, from wage- 
earners in the West whose wages have been made 
higher by the movement to the land so stimulated 
by the prospect of securing a profit from its 
appreciation. Under the present land system, 
the rental compensation to the western landowners 
comes from people living in the West, and mostly 
from people who came a little too late to get land 
for themselves, or, in some cases, from people 
who had other ambitions. It is these people 
whose coming and whose demand for the use 
of the land bid up land rents. To them, as per- 
sons who have come to be inhabitants of the 
West, any artificially induced scarcity of labor in 
the East is no longer — if, perchance, it once was — 
an advantage. Their wages are not higher, but 
lower, in the long run, than if the West were 
less completely settled. For the marginal product 
of western labor is presumably less. The old 
alternative of taking up new and good land is 



^6 Cf. Professor H. J. Davenport's article entitled "Theoretical Is- 
sues in the Single Tax," in the American Economic Revieiv, March, 
1917, especially pp. 22-26. 



220 Earned and Unearned Incomes 

gone. Of course, so long as there was still other 
new and good land to be had, even western wages 
must have been kept up by the rush of labor to 
this land, but this would not continue to be the 
case as the land filled up and as the available free 
land became progressively poorer.^^ 

In what sense, then, and how far, were the 
benefits of rising land values diffused? Was it in 
such a sense that the descendants of those who 
did not take up land must, in justice, pay the 
descendants of those who did, for the privilege of 
living and working on it? Are the descendants 
of those who did not acquire the land to be re- 
garded as having so gained from the possibly 
slightly larger labor incomes of their grandfathers, 
or to have so lent their moral sanction to the 
system, as to be under obligation not to change 
it, even where cities have grown up and have 
made land which was worth its hundreds of dol- 
lars now worth millions? Is it their social duty 
to go on paying indefinitely for the use of land 
which would be equally available and which would 
be about equally desirable if any individual owner 
to whom or to whose descendants the payments 
for its use are made had never lived? Or can 
society in general be regarded as having ever 
even impliedly pledged itself that the increase in 
land values resulting from social growth should go 

^'^ Furthermore, the consequent inflow of new labor from the 
East and of immigrant labor into both East and West tended, by 
rapidly filling any vacuum, to prevent any considerable realization 
of such a gain in wages. 



Rent of Land and Its Taxation 221 

entirely to individuals and should not be subject 
to any considerable taxation by states or cities? 
Is it not, indeed, clear that we are very definitely 
maintaining a land system which makes part of 
the public pay large sums annually to the rest 
of the public for no service that the recipients 
of these sums, or their ancestors, or any other 
landowners as such have ever rendered to the 
persons from whom their rental incomes are de- 
rived? Why are those who thus pay without 
getting, under an obligation to maintain the sys- 
tem and to continue paying through all future 
time? Must countless generations of the disin- 
herited be held under obligation to pay for a 
somewhat problematical ''diffusion" benefiting some 
of their ancestors, a diffusion from which most 
of the descendants of those who may thus have 
somewhat benefited have very likely realized 
nothing whatever? We do not allow the creditors 
of a father to require payment for the father's 
debts from the labor income of a son, however 
much the father may have gained — in his life- 
time — by his borrowing, nor do we insist on "com- 
pensation" to a creditor who is therefore unable 
to recover. We adhere to this policy because we 
do not consider it socially desirable to make one 
class partially the slaves of another class, to com- 
pel them to spend part of their time working for 
that other class without return from the latter, 
even though the latter class may conceivably have 
rendered a real service to the ancestors of the 
class that pays. May it not be as much contrary 
to good public policy to recognize any implied 



222 Earned and Unearned Incomes 

contract by which, as an offset to the possibly 
temporarily larger incomes of one class, the des- 
cendants of that class have to pay others for the 
use of the earth? Is not the recognition of any 
such implied contract equivalent to recognizing 
the right of men to sell their children or their 
grandchildren into slavery? We v^ould not recog- 
nize the latter right, in our society, directly and 
avowedly, even if the children were sold to get 
food to save their lives. Must we recognize the 
former? It is true that, in the case of land rent, 
we associate the payment made with a material 
thing, the land, but are we not, nevertheless, in 
essence, dealing with a payment for which no 
service is rendered? 

Let no one conclude that our argument tells equally 
against all inheritance on the ground that those 
who pay interest for the use of capital accumulated 
by previous generations are paying for a service 
to persons who did not contribute that service. 
For it well may be, in the case of inheritance of 
capital produced by human labor, that the prospect 
of descendants* reaping return from it is a 
condition without which, in great part, it would not 
be saved. If so, the interest is paid for a service 
which, except for the prospect of interest pay- 
ment to descendants, might never have been 
rendered; it is paid for the use of capital which, 
except for expectation of reward to descendants, 
might never have been added to society's equip- 
ment. As long as the family affections endure in their 
present strength much of the happiness of parents 



Rent of Land and Its Taxation 223 

will be realized only as they are permitted to 
work for the future prosperity of their children. 
General welfare and happiness would probably not 
be furthered by a policy which should entirely 
deprive parents of the privilege of bequest. Nor 
would the community probably get, in the long 
run, the use of so much capital, for less would 
probably be accumulated. A parent will be less 
likely to save and to invest his earnings in 
the education of his children if he believes so- 
ciety will appropriate all the gain and will not 
allow his children to reap a larger income for 
the larger service which such education enables 
them to render. And in like manner, a parent 
will be less inclined to save and invest in capital 
construction if he believes that society will allow 
his children to reap no advantage in return for 
the service from such capital. 

There is no intention to suggest, however, that 
inheritances should never be taxed or that the 
law of inheritance is not in need of modification. 
When, as at present, the state provides for inherit- 
ance of the property of intestate decedents by 
remote collaterals who have often been unac- 
quainted with their unconscious benefactors, it can 
hardly be said that the policy adopted has been 
dictated by the necessity of encouraging accumula- 
tion or by the desirability of giving men and 
women the happiness of safe-guarding the future 
welfare of those for whom their affections are 
strongest. 

But whatever may be the advantages to the 
general welfare of maintaining in considerable 



224 Earned and Unearned Incomes. 

degree the right of bequest, there appears to be 
no reason to believe that to keep the major part 
of ground rent from going into the pockets of 
individuals would decrease the amount of land 
or the amount of any other capital. 

If it is said that the western homesteaders 
sometimes had to fight the Indians, it can also 
be said that they frequently and largely received 
protection from the United States army paid for 
out of the general tax fund; and it may well be 
that men who served in the army and gave such 
protection, or men who contributed in taxes to 
maintain it, afterward came to have to pay, for 
the use of land, persons so protected. It is to be 
questioned whether any service of the pioneers, 
still less of the droves of later settlers, who follow- 
ed them while the land was still cheap, was so 
important and far-reaching that their descendants 
can be held to have acquired a right to receive 
tribute for all future time because of this service, 
and that the millions of dollars of situation rent 
in the cities of Chicago, St. Louis, Denver, Los 
Angeles, and San Francisco really all represent 
legitimate payment from later comers and their 
descendants for the equivalent services to these 
later comers and their descendants, of those who 
chose to come first. Surely, one who holds this 
needs take but a short step farther to prove that 
the whole idea of the unearned increment is a 
myth, or the product of diseased imagination, and 
that, really, anything that anyone gets is earned 
by equivalent service to the one who pays it. 



Rent of Land and Its Taxation 225 

§ 7 
Ovjnership of Land by Small-Family Groups ver- 
sus Increasing Population in Other Groups 

A special phase of the land problem arises in 
connection with the rights of small holders of 
land whose land has been handed down to them 
by ancestors who have deliberately, when popula- 
tion was increasing, kept their own families small, 
and who have hoped, thus, to bequeath to their 
children a sufficiency of land for the latter's use. 
We may advantageously approach this problem by 
considering a related one — that of immigration. 
There seems to be a growing opinion that a highly 
civilized and prosperous country having a low 
birth-rate may properly protect its standards of 
living and of wages by excluding from its shores 
the teeming millions of more prolific races whose 
multiplication reduces them to poverty at home 
and whose invasions of other and happier lands 
tends to make such poverty world-wide. To let 
them enter may only make room for new millions 
in their native country, relieve the poverty of that 
country but slightly, and add to it the poverty, 
due to immigration, of the low birth-rate country. 
Yet the latter country, if it practices exclusion, is 
maintaining a monopoly of its land for its relative- 
ly sparse population, and is shutting out from any 
possible use of this land the millions who fain 
would come. 

What now of the thousands of families in a 

country who have each enough land for the most 

efficient application of their own labor and for 

comfortable subsistence and who, by limitation of 

15 



226 Earned and Unearned Incomes. 

offspring, are preventing the undue subdivision of 
such land into small plots — who are doing their 
share in keeping up the general level of comfort 
by trying to prevent too great an increase of 
population in relation to available land? If the 
rest of the nation multiplies quite without regard 
to natural resources or land space and so forces 
down the margin of labor production, does society's 
right to land space justify redividing the land 
equally, thus directly depriving the families which 
have kept down their numbers of the standard of 
comfort which would naturally result from their 
low birth-rate? Or does this right of society 
justify a system of taxation of rental values which 
indirectly accomplishes the same result? For it 
should be clear that if the land so held by individ- 
ual families comes to be more valuable, not by 
virtue of its yielding more, but solely because 
pressure of population increases the demand for 
it, then to take the greater annual value in taxa- 
tion will leave less to the owners than before. To 
express differently the same thought: if the policy 
of state appropriation of land rent is consistently 
applied, so that individuals get only the earnings 
of their other capital and the wages of their 
labor (employed or self-directed) , then an increase 
of population which lowers the marginal product 
of labor will not only enable the state to collect 
more than previously from individual landowners, 
but will leave less to them as individuals and 
families than before. Such an increase of popula- 
tion will leave less than before even to those 
families which are in no way responsible for the 



Rent of Land and Its Taxation 227 

population increase from which flows their new 
family poverty. For this reason — viz., because it 
would remove a stimulus to desirable limitation of 
offspring, because it would penalize the far-seeing, 
because it would give to families whose ideals tend 
toward universal misery the inheritance of those 
families whose ideals, if generally adhered to, 
would bring universal plenty — such appropriation 
of all rental values of land might not be a desir- 
able social policy. Part of the rental value of 
land, even of agricultural land held by actual 
cultivators, may, perhaps, fairly be taken, but not 
all. 

To illustrate the principle involved, suppose a 
piece of land capable of supporting a man and his 
family, a piece of land just large enough to utilize 
one man's time to the best advantage. Further labor 
than he could give would then be attended with di- 
minishing returns. To make the illustration quanti- 
tative, we will assume that on this land the labor of 
one man will produce 500 units (e. g., bushels of 
wheat), of two men, 900, of three, 1,200. If, at 
the start, the land is marginal, the occupant and 
owner will enjoy 500 units of labor income. If 
population increased to such a point as to force 
wages for this grade of labor to 300 or less, he 
could afford to hire, perhaps, two other men, since 
the second would add just 300 to the product; he 
would therefore pay 600 in wages to the two men, 
would receive 300 in labor income for himself, 
and would have 300 left as rent.^^ The owner's 

1^ For simplicity we are eliminating income on other capital 
from consideration. 



228 Earned and Unearned Incomes. 

total income would then be 600. We could take 
100 of this in taxation and still leave the owner's 
combined rent and labor income at 500 which he 
was getting as a labor income, with no more total 
effort, before. But if we take all of the rent in 
taxation, we leave him only his 300 labor income, 
which is not much over half of his previous income ; 
and we have subjected him to deprivation through 
an increase in population for which he was not 
responsible and which was clearly undesirable from 
the point of view of general welfare. 

However, in practice the increase of land 
values is usually in large part an increase in the 
value of special sections of land which growth of 
population causes to become more advantageously 
situated in one or more ways. As the country 
grows, certain places come to have new and special 
advantages as market centers, as ports, etc., and 
thus acquire an increased rental value not depend- 
ent on a lowering of the margin of production. 
Increase of population in a fertile, unsettled plain, 
containing a great deal of land of approximately 
the same fertility, might not for many years lower 
the marginal product of labor. To be sure, the 
later settlers might have to go farther, but the 
more distant points would be no more isolated 
than the first-taken land was at an earlier date, 
and the extension of roads and railroads might 
make then less so. Rent would rise, not because 
the margin has become lower, but because the 
situation of a part of the land relatively to 
markets, population centers, etc., has become better. 
Still more clearly does this fact stand out when at 



Rent of Land and Its Taxation 229 

some point on the plain a city develops, called into 
existence by the increasing number of those whom 
its merchants, artisans, etc, can effectively serve. 
Its growth is, possibly, an advantage even to the 
owners of marginal land, but confers a special ad- 
vantage on those whose near-by location enables 
them to reap exceptional profit from supplying the 
city needs as to produce. The grov^h of the city 
confers a still greater advantage on those whose 
land comes to have value for distinctly urban uses. 
The occasional settler who or whose descendant 
finds that his land is in the center of a thriving 
city may become a millionaire as a consequence 
of conditions to which his own contribution was 
negligible if anything at all. In this case and, in 
general, in a country like the United States, land 
rent has probably grown much more largely by the 
increase of the possibilities of special, often supra- 
marginal, land, thus creating a differential between 
it and marginal land, than by forcing cultivation 
to a lower margin. In short, any desire that we 
may feel to protect small landholders who limit 
their families from being made to suffer through 
the general increase of population, need not prevent 
us from taking, in taxation, most of the rental 
value of land, including that of mines and power 
sites, and nearly all of the rental value flowing 
from its situation of city land. 



230 Earned and Unearned Incomes. 

§ 8 

The Bearing of the Contention that there may he 

Other Unearned Increments Not Especially 

Associated tvith Land 

It has sometimes been pointed out, by way of 
objection to the single-tax proposal, that land rent 
is not the only income which is of the nature of 
an unearned differential. Sometimes the incomes 
of genius in excess of what persons of ordinary 
ability can secure are presented as an analogous 
case. Whatever may be, in some respects, the 
degree of likeness, the two cases certainly are not 
alike in all respects. Thus, it may not be equally 
possible to tax largely and successfully the incomes 
resulting from the exercise of genius, as to tax 
land rent, for, in the case of the large incomes of 
the exceptionally gifted, the attempt to tax them 
heavily might conceivably discourage effort and 
cause the former recipients of these incomes to be 
satisfied with smaller — and, therefore, untaxed — 
returns. Taxation of the rental value of land, 
however, if based upon such general considerations 
as the evident yield of neighboring sites and the 
apparent market value of the land to be taxed, 
i. e., if the tax is not made larger because an 
efficient producer or business man gets more from 
his land than others could get, would probably 
in no wise affect the owner's choice of uses for the 
land or his intensity of use of it or the efficiency 
of his use of it. Having a tax to pay which was 
independent of his efficiency, he would be just as 
eager to earn the maximum income out of which 



Rent of Land and Its Taxation 231 

to pay the tax as he would be to earn the maximum 
income if he were not taxed. 

Indeed, the levying of a tax upon the potential 
situation rent of land, whether actually received 
or not, would discourage the speculative holding of 
land out of use and so would operate to prevent 
the forcing up of rent by any scarcity of available 
land induced by such speculative holding. 

Economists whose social sympathies (of the in- 
fluence of which they are not always conscious) 
or whose training by their former teachers, in- 
capacitates them for seeing any distinction be- 
tween land and capital and predisposes them to 
accept superficial resemblances as a conclusive 
defense, are fond of saying that other values 
than land values are enhanced by social forces. 
It is true enough that dress suits are likely to 
have less salable value in the Ozark Mountains 
than in the centers of wealth and fashion and that 
a twenty-story office building is worth more in 
New York City than in a country village. Never- 
theless, cases of monopoly excepted, it can hardly 
be denied that, year in and year out, produced 
goods cannot be sold anywhere for much more or 
much less than the cost of producing them in the 
places where they are to be sold. An occasional 
dress suit may have to be sold at a sacrifice in 
the Ozarks, and a building too large for the needs 
to be met may prove to have been a mistaken 
investment in the country village. But as a 
general rule dress suits will not be produced in 
or transported to the Ozarks except as the antic- 
ipated price covers costs, nor will skyscrapers 



232 Earned and Unearned Incomes 

be regularly built to sell for less than a return 
which seems reasonable in relation to building 
expenses. And, on the other hand, where com- 
petition is active and is carried on fairly, the 
prices of goods which have to be humanly produced 
cannot go much above costs. Even making all 
possible qualifications for cases of obsolescence and 
for changing conditions of production, can anyone 
say that cost is really an element of corresponding 
significance in the case of land rent? 

Again, it may be said that there is possible no 
large remuneration, in a sparsely settled primitive 
community, for the person gifted with an ex- 
ceptional voice or other highly specialized talent. 
But neither is so large a service possible in 
return for the remuneration. When such re- 
muneration is received it is in return for an 
equivalent service rendered by the person who 
receives it, and this is not the case with the 
situation rent of land. May not considerations of 
eugenics as well as of efficiency in service, apply 
differently to the proposition to tax such incomes 
than to the proposition to tax land rent? 

Furthermore, some of the incomes which are 
often thought of as unearned are chance gains so 
offset by corresponding deficiencies of incomes at 
other times, as to mean no average loss to the 
public. If the failure of the Argentine wheat 
crop may unexpectedly give to American farmers, 
grain dealers and millers a higher return than 
was contemplated when they made their expendi- 
tures for seed, labor or grain; so, also, an un- 
expectedly large crop of wheat in Argentina, 



Rent of Land and Its Taxation 233 

Canada, or elsewhere, may compel the same persons 
to accept prices which fall far short of compensat- 
ing them for the expenditures and effort under- 
gone. The general public is likely to gain in the 
latter case as much as it loses in the former. But 
the general public never gains from an unexpected 
fall in the rental value of land except in the 
sense that the public is then less exploited than 
before. It continues to be exploited, though in a 
smaller degree. There is little point to an attempt 
at equating continuous exploitation varying in 
degree, with occasional excess pay for service 
which is likely at other times to be underpaid. 

It will be worth while, here, to emphasize the 
fact that land rent involves exploitation when 
the land is used in socially desirable ways as well 
as when it is used anti-socially. In the latter 
case, payment is made for a disservice. But even 
in the former case payment is made for a zero 
service or for a service less than equivalent to the 
rent. Where wages of labor, interest on capital 
or rent on land are secured by activities or by 
uses of property which definitely injure the 
general well-being, which are anti-social, these 
activities or uses should be prohibited rather than 
that men should be allowed thus to secure wealth 
which society afterwards taxes. When a business 
concern by means of unfair competition, e. g. by 
misrepresentation of competitors' goods or by 
securing discriminating rates on the railroads,^^ 

19 See, for a fuller discussion along this line, the author's Prin- 
ciples of Commerce, New York (Macmillan), 191 6, Part III, Chap- 
ter VII, § 4. 



234 Earned and Unearned Incomes 

succeeds in getting extra profits which its rivals 
do not get, or, being able to undersell the rivals 
discriminated against, gets business which would 
otherwise go to them, we have a clear case of 
unearned income resulting from anti-social activity. 
Success is made to depend, not on superior service, 
not on superior efficiency in economizing labor, 
but on the ability to exclude rivals from the 
market even if, as may well happen, these rivals 
are much more efficient in the proper business of 
both or all. The public cannot afford to let the 
principle become established that success and 
wealth may be gained by such methods. In the 
long run, consumers must expect to suffer unless 
competition of this sort is effectively forbidden. 
So too, in the case of monopoly, which gives 
more than an ordinary return to effort or to the 
users of capital or land, it is the consumers of the 
monopolized article or articles who are entitled to 
relief since it is they alone who are exploited.^^ 

20 No opinion is here expressed regarding the relative desirabil- 
ity, from the viewpoint of preventing high monopoly prices to con- 
sumers, of public regulation and of public operation of industries 
vs^hich have to be or ought to be of monopoly size- But if public 
operation is chosen, it would seem, on the principles set forth in 
this book, undesirable that the public should pay for the capitalized 
value of the land rent included in the prospective returns of such 
monopolies. If not to pay for such capitalized exploitation in cases 
where the public chooses to take over the ownership of any in- 
dustries is objectionable as discriminating against some landowners 
while allowing others to continue to enjoy site rent, then the taking 
over of these industries by purchase should be deferred until a gen- 
eral policy is adopted towards all site rent. Nor should government 
for any long period guarantee interest or net dividends on the 
bonds or stocks of companies whose property it undertakes to oper- 



Rent of Land and Its Taxation 235 

In general, industrial free-booting should be stamp- 
ed out, so far as this is possible. But for un- 
earned income in the form of land rent, purely as 
such, the tax method is adequate and is the logical 
method of correction. 

Again, even if there are — as there may be — 
other increments than situation rent which are 
equally unearned, it does not follow that the 
heavier taxation of land values should be deferred 
until such time as a general agreement is reached 
regarding such other increments. It may suit 
the views of reactionaries to have us use the 
claim that many and complicated reforms are 
needed, as a reason for delaying one the justice 
and desirability of which are reasonably evident, 
but that kind of attitude should scarcely suit 
anybody else. 

§ 9 
The Taxation of Future Increments of Value 

Hesitating to accept the more radical proposal 
of Henry George in favor of sweeping into the 

ate. For suppose that during the period of such a guarantee, one 
or several of the States, or the Federal government Itself, should 
choose to adopt a new tax system, e. g. to Increase very greatly the 
tax on site values. This would for all other Industries than the 
ones In question diminish the land-rent part of their Incomes, though 
to be sure, removal of other taxes might Increase other elements in 
their incomes. But, whatever the net result on these other indus- 
tries, the holders of the securities of the government-operated indus- 
tries would experience no effect as regards their annual returns. The 
better way would be to guarantee (If there is to be a guarantee of 
past earnings) previous earnings plus previous taxes minus future 
taxes. 



236 Earned and Unearned Incomes. 

public treasuries situation rent both new and old, 
some writers have contented themselves with 
advocating the public taxation and use of future 
increases in the rental value of land.^^ This 
advocacy, they seem to have felt, frees them 
from the necessity of urging anything that looks 
like confiscation. But there are reasons for think- 
ing that if the more radical proposal involves 
confiscation, the other does also, though it may 
be less in degree; and it is doubtful if the more 
moderate plan can be successfully defended without 
raising a presumption that the more far-reaching 
scheme has also something in its favor. 

To the proposal that only future increases in 
rental value be taken by the state, it has been 
answered that to take future increases without com- 
pensating landowners in the case of future de- 
creases in the value of their land unfairly deprives 
them of the chance of gain while still leaving them 
the risk of loss. In the words of F. A. Walker, 
''the game of 'heads I win, tails you lose' is not 
one in which the state can, in fairness and decency, 
play a part."^^ If one believes that the present 
rental yield of land, as well as future increases of 
this yield, should not go to the private owner, this 
contention will not disturb him. Otherwise it may 
seem to be convincing. 

There still remains the argument, however, that, 
in a growing country increases are frequent and 

21 See, for example, Taussig, Principles of Economics, New York 
(Macmillan), 1912, Vol. II, p. 102. This scheme was suggested by 
John Stuart Mill in the middle of the last century- 

^^ Political Economy, Advanced Course, New York (Holt), 1887, 
pp. 416, 417. 



Rent of Land and Its Taxation 237 

decreases rare and that, therefore, no large 
injustice would be done by the scheme. But what 
if the opposition contends, as it plausibly may, 
that the present owners of land have, in many 
cases, bought it at prices which they were willing 
to pay only because of the prospect of future 
increases? The opposition may contend, in other 
words, that expected future yields have been dis- 
counted into the present price of the land, and that, 
therefore, to tax heavily these future yields will 
deprive such purchasers of an income they paid 
to receive, and will depreciate the value of their 
land below the price at which they bought it. 
Some increases, to be sure, may come as unfore- 
seen luck, but many must be, at least in part, 
anticipated. Is a tax on such increases any 
less "confiscation," so far as the capitalized value 
of land is concerned, than would be a moderate 
increase in tax which would take away a part of 
the constant annual rent of a piece of land bought 
with no expectation of a rise, but bought in the 
belief that its owner would be left undisturbed in 
the enjoyment of the entire rent? 

Without now pursuing this comparison further, 
we may note that a doctrine according to which 
the public has no right to take by taxation future 
increases in land values, increases not earned by 
any service rendered by the landowners, must, 
logically, be opposed to other governmental policies 
of which most of us are in favor. Such a 
doctrine would mean, for instance, that the pur- 
chaser of stock in a company which contemplated 
— or the purchaser of whose stock foresaw the 



238 Earned and Unearned Incomes. 

likelihood of its undertaking — selling out to, or 
becoming part of, a monopoly and so securing 
monopoly profits, since such purchaser paid more 
for his stock because of this expectation, must be 
allowed to enjoy these monopoly profits, or, if they 
are taken away from him, must be compensated. 
Has the purchaser of stock under circumstances 
of this kind any such claim even if the policy of 
limiting monopoly profits is one which was not 
previously in force but was adopted after he 
purchased the stock? 

§ 10 

Land-Value Taxation in Relation to the Theory of 

Vested Rights 

The principal objection actually felt, if not the 
one chiefly emphasized by opponents of land-value 
taxation, is an objection based upon respect for 
vested rights, viz., that such a scheme of taxation 
would take away from the owners of land a large 
part of the capitalized value of their property by 
making it impossible for them to enjoy from it the 
expected future income. If a piece of land yielding 
$1,000 per year is valued on a 5 per cent basis, 
its selling price would be $20,000. To take $200 a 
year would mean, since a tax on land rent can- 
not be shifted, that the selling price of the land 
must fall to $16,000. Hence, it is said, since 
such taxation takes from the owner a fifth of the 
value of his property, it is confiscation and a 
denial of vested rights. Of course what we def- 
initely take is a fifth of the yearly income, but 



Rent of Land and Its Taxation 239 

since the value is dependent upon the income, 
the establishment of such a tax as a permanent 
part of the tax system in effect takes one-fifth of 
the capital. But how is it if through indirect taxa- 
tion we take $100 a year from the family of a 
workingman whose annual income is $500. If 
the man's expectation of life is thirty years, 
would not the capitalized value of his income be 
well in the thousands of dollars, supposing it to 
be salable? And would not this capitalized value 
be reduced one-fifth by a tax of $100 per year if 
such a tax were adopted as a permanent part of 
the tax system? To be sure, workmen are not in 
the habit of thus capitalizing and selling the 
right to their future incomes, but is the injury to 
them from a tax any the less for that, or the funda- 
mental nature of the problem essentially different? 
If a need of increased revenues were thus met, 
there might be sympathy expressed for the working 
classes and objection to the tax as an undue 
hardship upon them, but the word "confiscation" 
or the expression "vested rights" probably would 
not be used. No complaint would be made that 
the fundamental rights of property were being 
invaded or that society had violated any implied 
pledge. 

It seems to be this last motion, that of an implied 
pledge or sanction given by society, which makes 
many thinkers regard so askance any proposal for 
radical changes. We must not take rent in taxation 
because the enjoyment of it is a vested right. 
"Society" has allowed individuals to appropriate 
nearly all of rent in the past and various persons 



240 Earned and Unearned Incomes. 

have bought land, relying upon the continuance 
of the system. Hence the private enjoyment of land 
rent must always be allowed unless compensation 
is paid by the dispossessed to the possessors. 

If we are perfectly frank in our adoption of 
this vested-rights argument as a reason for re- 
fusing to take from those enjoying them incomes 
not earned by service given to those who pay them, 
we shall have to admit very frankly that several 
types of income ordinarily objected to by econo- 
mists must be continued indefinitely. Thus, in 
consistency, we must protest against any regula- 
tion of monopoly which will do away with the 
monopoly prices on which any monopolists had 
counted, and particularly so if the monopolists have 
bought stock at a higher price because of the ex- 
pectation of monopoly profit. "Society'* has per- 
mitted this profit in the past, has lent its "sanc- 
tion'* to it, has allowed people to buy stock in the 
expectation of realizing an exceptional profit. May 
society, therefore, by its regulations cut down this 
profit? Must it not pay the monopoly prices in- 
definitely or else compensate the monopolists by 
paying them in advance the capitalized value of 
their expected future monopoly profits? 

So, again, if we would be perfectly consistent, 
we must not remove the protective tariff on goods 
when those who have invested in the companies 
producing such goods have paid more for their 
stock than they would otherwise, in the expecta- 
tion of deriving protected profits. In other words, 
since, largely through the influence of those 
engaged in protected industries, the policy of 



Rent of Land and Its Taxation 241 

protection has been maintained for a limited 
number of years, society at large owes such 
industries a continuance of favor. In still other 
words — for this is the inescapable implication — 
those who wish to consume the protected goods 
may properly be required to pay for these goods 
an excess price, a price above the real value of 
the service given. In this view of the case, the 
taxed class, being part of society, has some sort 
of responsibility for what society has done, even 
for what the class that profits by protection has 
influenced society to do, and has no right suddenly 
to refuse longer to pay tribute to the protected 
class. 

The foregoing is a view which the writer cannot 
bring himself to accept. Society is under no obli- 
gation nor is any class in society under an obliga- 
tion to pay tribute to any person or group of 
persons for all future time. Still less is a class 
which, while another class has controlled govern- 
ment, has been exploited, under obligation to con- 
tinue to let itself be exploited if and when it is 
able to get into the saddle. Society as such has 
given no pledge, and is not in a position to give 
a pledge, that its policy will not change. Those 
who buy stock in a monopoly or invest their 
money in a protected industry must be held to 
have done so, not under any guaranty of perma- 
nence, but at their own risk, knowing it to be the 
right of the rest of society to cease paying the 
excess prices and adopt a new policy at any time. 

How does the matter stand in the case of land 
values? Is it correct to think of land-value taxa- 



242 Earned and Unearned Incomes. 

tion primarily as a system of taxation that in- 
fringes on vested rights by taking something away 
from landowners? Is it not more enlightening to 
call to mind that, indeed, the rest of society is 
continually (weekly, monthly, or annually) ^^ pay- 
ing tribute to the owners of land, tribute for which 
neither these owners nor any previous owners as 
such have ever rendered a return to those who 
thus pay them? When we say that for the public 
to take in taxation most of the rental value of 
land would be to confiscate the "property" of those 
who had previously enjoyed this rent, do we not 
express the fact the wrong way about? Would 
it not be nearer the truth to say that the rest of 
society simply refuses longer to have its earnings 
confiscated by the landowning class? Does the 
situation value of land, the value apart from im- 
provements, represent anything else but the esti- 
mate, in a present valuation, of the future tribute, 
the future payments without corresponding serv- 
ices, which the owners are in a position to get 
from others? Are not the masses paying a 
perpetual tax to the owners of land for the 
privilege of living upon, and making use of, sites 
which were neither produced nor rendered valuable 
by the owners? Suppose the masses who are thus 
paying tribute without receiving either labor 
services or more capital equipment for production 
than would otherwise be available, or indeed any- 
thing else worth the price, simply decide to stop 

23 Cf. Henry George, Progress and Poverty, Book VII, Chapter 
III, particularly pp. 362 and 363. (Page reference is to edition of 
1905, Doubleday, Page & Co.) 



Rent of Land and Its Taxation 243 

paying this tribute! Would their doing this be 
confiscatory? And must they, if they are to 
cease paying, compensate the landowners by giving 
to the latter interest-bearing bonds worth as 
much as the land, and payable finally, as to interest 
and principal, by the same persons who now pay 
rent? Is this not equivalent to saying, not only 
that those who are slaves in the sense that they 
devote much of their labor to the support of a 
parasitic class cannot be freed without provision 
for compensating the parasitic class, but also that 
the compensation must be provided by the slaves? 
Could we reasonably expect the slaves, once they 
were in the saddle politically and thoroughly under- 
stood the matter, to take this view of it? 

As an analogy to the payment of tribute for the 
use of land to persons who are in no way responsi- 
ble for its existence, let us suppose that an 
ancient king or a small ruling caste has some- 
where given to a favorite or to someone of 
political influence the negotiable privilege of collect- 
ing each year a certain amount of the taxes and 
turning them to his own use. The favorite later 
sells his "right" to another for a large sum of 
money which that other had honestly earned by 
hard and faithful work at a useful task. Some 
time after this second arrangement is made, the 
taxed class overthrows the power of the king or 
aristocracy and establishes itself in power. Must 
this class go on contributing the tax because the 
would-be recipient paid to get it, notwithstanding 
he paid nothing to those whom he now expects to 
pay him? And if they refuse, using the money in 



244 Earned and Unearned Incomes 

question instead as part of their general tax fund 
for common purposes, are they guilty of an im- 
moral act? Must not the would-be collector of 
tax money be assumed to have made his purchase 
subject to the condition that society could in its 
own good time make such changes as its members 
might see fit? And if the remainder of society 
came to believe that, in the long run, the greatest 
good to the greatest number would be attained by 
establishing a system in which, in general, each 
should profit according as he served, and in which, 
except as some special social reason justified the 
apparent exception, no one might receive tribute 
from those he did not serve, would not society 
have a moral right to establish such a system? 

, §11 

A Few Additional Considerations 

The truth is that few of those who advocate 
large taxation of land values, even of the single- 
taxers, urge any but a gradual change in the 
rate of taxation of land. A sudden break with the 
past is not sought for. Nor, if it were, would 
there be any serious likelihood of its coming. 
Though we may work for the change with ardor, it 
will come through compromises and little by little 
and, probably, through state and local action. 

Even if, here and there, a town or city increases 
rapidly the amount of tax it puts upon land, this 
may not, while the new system is not general, 
cause very considerable loss to landlords. For 
it will be likely to mean that in those cities 
businesses and individuals are relieved of other 



Rent of Land and Its Taxation 245 

taxation which elsewhere they have to meet, and 
the policy will, therefore, probably cause these 
towns to be more rapidly settled and land rents 
in them to go up.-* This is a result which would 
not be brought about if the equally rapid increase 
of land-value taxation in other places kept the 
balance.^^ 

Furthermore, even if the tax were generally 
applied, no great loss would fall on small land- 
owners who have improved their land and who 
themselves live on it, persons who own their own 
homes and little else, since to them it makes 
relatively little difference whether the principal 
tax is on buildings or on land.^^ But to persons 
owning land and buildings which are used by 
others or for the production of goods to be sold 
to others, it may make a considerable difference, 
since the tax on land clearly cannot be shifted 
(if general), while the tax on buildings very 
possibly can be, at least to some extent.^^ 

2* Suggested by Professor H. J. Davenport's Exercises, printed 
to be used with his Economics of Enterprise. Cf. pp. 28 and 29 
of Professor Davenport's article in the American Economic Review, 
March, 1917. 

25 Some may regard it as an objection to a purely local applica- 
tion of anything approaching the single tax and the local use of the 
funds derived from it, that such a policy gives to labor in the town 
adopting it a benefit more than it receives elsewhere and therefore 
induces labor to come to such a city when otherwise it would stay 
away, and, by inducing surplus labor to come, brings diminution of 
the product of this particular labor. 

26 Cf. Henry George, Progress and Poverty, Book IX, chap. iii. 

27 V^hether a tax on all the earnings of capital regardless of 
the line of investment could be shifted and to what extent, would 
depend on whether and how far such a tax diminished saving. See 



246 Earned and Unearned Incomes 

The removal of taxation from all capital and 
its concentration on land values would of course 
involve an increased burden to those whose 
property was chiefly in land values. But the 
immediate loss to the person who owned both 
land and capital would be minimized by the fact 
that he would be enjoying relief from taxation on 
his capitaps (^j^^ interest from which, if the 
capital was being used in socially advantageous 
ways, would be earned), at the same time that he 
was being made to pay heavier taxes on his land 
(the situation rent of which was principally un- 
earned). In the end, the removal of taxation on 
capital would presumably reduce interest rates if 
the leaving of larger net returns to owners of 
capital operated to encourage capital accumulation. 
But for some time the average property owner 
would probably be largely compensated in his 
greater net interest on capital, for the reduction 
by taxation of his net rent on land. 

In truth, when all is said regarding confiscation, 
we must recall that government cannot possibly 
raise revenue without taking something from some- 
body. And if we have to choose between taking an 
unearned income already being collected by part 
of us from the rest of us, or allowing part of 
us to enjoy such an unearned income and taking 

the discussion of the effect of interest on saving, in Chapter III, 
§ 5 (last three paragraphs of section). 

28 If the shift in taxation from capital to land were great and 
sudden, therefore, the rate of interest would be temporarily higher 
and whatever was left to landowners of site rent would have to be 
capitalized, for a while, at this higher rate. 



Rent of Land and Its Taxation 247 

something more, in taxes for common purposes, 
from the rest of us, the choice should not be 
difficult. 

Nor should we be turned back by the contention 
tliat the proposal so to raise much or most of the 
public revenues, at least for local and, perhaps, 
State purposes, does not conform to the ability 
theory of taxation. It has never been finally es- 
tablished that taxation ought to be in proportion 
to ability. Taxation ought to be arranged with a 
view to societal welfare, and this may or may not 
mean that it should be in proportion to ability. So- 
cietal welfare may be better furthered, for in- 
stance, by preventing exploitation and the conse- 
quent receipt of unearned income, than by mathe- 
matical precision in apportioning taxes to total 
income of all sorts. The ability theory of taxation 
rests upon much the same ground as the theory of 
charitable relief. In the case of charitable relief 
it is argued that the sums thus expended have a 
greater (marginal) utility to the poor and helpless 
who receive them than to the relatively prosperous 
who contribute them (voluntarily or otherwise). 
In the case of taxation it is argued that a large req- 
uisition from one who is prosperous may involve 
less deprivation and sacrifice than a small requisi- 
tion from one who is comparatively poor, or, other- 
wise expressing the same idea, that to take money 
from the well-to-do, even though they have fairly 
earned it by giving equivalent service, and to ex- 
pend it for public purposes so that a large part of 
the benefits from its expenditure is received by the 
relatively poor, will increase utility and will in- 
crease the sum total of happiness. Assuming 



248 Earned and Unearned Incomes. 

wants to be equal, one might with some plausibility 
argue that the maximum of aggregate human hap- 
piness could only be attained by carrying this prin- 
ciple to the point of equalization of incomes. But 
long before incomes had been equalized the effects 
on efficiency of labor, perhaps, also, on the rate of 
accumulation, and, possibly, on biological selection, 
resulting from neglect of the principle of making 
incomes received depend on services rendered, 
would become serious. The greatest welfare would 
not be thus secured, in the long run. If, therefore, 
we venture to make some partial application, in 
our tax system, of the principle of equalizing in- 
comes, we must sharply limit our application of this 
principle in the taxation of earned incomes lest we 
depart too far from the principle of proportion- 
ing incomes received to services rendered. But 
whether or not there are classes which, because of 
their poverty, ought to receive from the community 
in personal incomes and in services from govern- 
ment, more than they contribute, in taxes and 
otherwise, to the community, it seems quite certain 
that the recipients of situation rent, as a whole, do 
not constitute such a class. If among themi are 
found the ubiquitous "widows and orphans" whose 
anticipated distressful state has been made the 
basis of opposition to many other necessary re- 
forms, it is better that society should make special 
provision for them in those exceptional cases where 
the shifting of the tax burden from other values to 
site values threatens them with poverty, than that 
it should forever maintain a bad system. Indeed 
there must be many widows and orphans who are 



Rent of Land and Its Taxation 249 

the victims of this system, of which some of their 
class may be the beneficiaries. 

Finally, high taxation of land values cannot be 
discredited by referring to its propaganda as an 
outgrowth of doctrines of "natural rights" while 
at the same time unconsciously appealing to what 
seem to be assumed ''natural rights of property." 
On the whole, the supporters of high land-value 
taxation seem to have been as consistent as their 
opponents in making their appeal to utilitarianism. 

There is here, it should be noted, no attempt to 
argue that the tax on land rent should necessarily 
be a single tax. A tax which would take the great- 
er part of site rent might or might not provide 
sufficient revenue to meet the legitimate expenses 
of government. It would perhaps provide all the 
funds needed for local and State governments and 
possibly, also, for ordinary Federal expenditures. 
But until permanent world peace is established, 
the Federal government needs a source or sources 
of revenue capable of great emergency expansion, 
such as is provided in the income tax and other 
Federal taxes. Extended discussion of the merits 
or demerits of these taxes, however, lies outside 
the scope of this book. 

§ 12 
Summary 

At the beginning of this chapter it was shown 
that land rent is fixed by the marginal productivity 
of land and is a surplus over the interest to waiting 
and the wages of labor, a surplus the amount of 



250 Earned and Unearned Incomes. 

which cannot be increased by the owners of land 
to make up for the taking by taxation of any per 
cent of it. The attempt was then made to dis- 
tinguish briefly between rent of land and interest 
on other capital. The situation rent of land we 
found to be an absolute amount, not determined by 
the value of the land or by its cost of production, 
but an essential element in the determination of the 
value of the land. The value of reproducible 
capital, however, was found to be directly deter- 
mined, in large part, by cost of production, analyz- 
able into alternative returns of the productive 
factors used. The productivity of capital appeared 
to be an important influence, perhaps the most 
important direct-acting influence, fixing the rate of 
interest. It further appeared that the interest on 
capital, when this capital is produced and saved 
by effort and waiting respectively, and when it is 
used in socially desirable ways, is earned. The 
interest is earned in the sense that the effort and 
waiting done by the producer and saver of the 
capital secure for the community as much of 
wealth as the capitalist receives in interest. On 
the other hand, the situation rent of land appeared 
to be a payment for benefits due to natural condi- 
tions or to social growth and not for services 
brought into existence by the owner of the land. 
Thus, the rest of the community is perpetually 
under taxation to support a class of landowners 
from whom, as such, no equivalent return is 
received. The landowner who has bought his 
land, though he has given an equivalent for it 
in value of something else, nevertheless cannot be 



Rent of Land and Its Taxation 251 

said to give a service to those from whom he 
derives rent, which would not equally have been 
available had neither he nor any other landowner 
ever lived. Hence the private receipt of rent 
violates the utilitarian principle that each should 
receive remuneration or income only in proportion 
to service rendered to those by whom the remuner- 
ation or income is paid. 

In the course of our study, however, it became 
necessary to make certain qualifications and to 
meet certain criticisms. The rent of land is clearly 
not all an unearned income. Part of it is interest 
on the cost of street-cutting, paving, etc., usually 
met in whole or in part by special assessments on 
owners of contiguous land. Since these owners of 
land chiefly benefit through a resultant increase 
in the rental and salable value of their land, it 
seems just that they should bear special assess- 
ments. But the justification of their having to pay 
these special assessments depends upon their being 
allowed to receive, in higher rental value of their 
land, a return on the cost of the assessments. Vari- 
ous alleged services of city landowners, such as 
exercising control over the class of tenants in any 
locality, or seeking out, developing, and advertising 
new sites, were next considered. The first did not 
seem to be a service for which we are necessarily 
dependent on landowners or, in any case, a service 
so costly to them in effort as to justify very much 
of rent. The seeking and advertising of new sites 
and bringing them into use at an earlier date than 
their advantages would otherwise be realized may 
sometimes be a service to the present generation, 
but is not clearly a service to later generations 



252 Earned and Unearned Incomes. 

who would eventually, with growth of population, 
have taken up this land anyway. Hence, if this 
is a service justifying rent payment, it can justify 
such payment only for a limited time. It is like 
the service of an inventor who gives us, somewhat 
sooner than we might else have it, the benefit 
of a new idea in mechanics, and to whom we give 
a definitely terminable right to receive royalties. 
So, also, we were unable to conclude that the early 
settlers in the American West had rendered any 
such economic services as to entitle their descend- 
ants and successors to receive rent for all future 
time from the descendants of later comers. For 
there seemed no clear indication that any benefit 
was received or is being received by the later 
comers or their descendants, from either the present 
or the former owners of the land. If the "benefit" 
of rising land values was "diffused" in any sense, 
the diffusion was not clearly to those of the present 
generation who now have to pay rent to use the 
land. They may well regard themselves, if they 
choose to recognize the authority in the matter of 
those who did it, as "sold out" by a previous genera- 
tion. 

Nevertheless we concluded that increased value of 
land resulting from increasing population v^ich 
forced down the margin of production ought not to 
be made an excuse for so taxing land rent as to 
leave with smaller incomes than before families 
which, to avoid overcrowding their own land, had 
refrained from rapid multiplication. The increase 
of those whose habits or ideals would eventually 
tend toward general misery ought not to result in 
so reducing the available space for cultivation or 



Rent of Land and Its Taxation 253 

in so increasing the tax on the land owned as to 
reduce greatly the incomes of a non-parasitic class 
with ideals of a different sort. This last considera- 
tion, however, seemed to tell with but little force 
against the high taxation of city land, since the 
value of such land is due mainly to increase of 
its special advantages rather than to a lowering of 
the grade of land at the margin of production. 

The argument that taxation of land values 
should not be much emphasized because there are 
other differential and unearned incomes, we con- 
cluded has little force. Most other unearned in- 
comes, such as those secured by monopoly and by 
industrial free-booting, require to be terminated, 
rather than to be continued in order that their re- 
cipient may be taxed. If there are other incomes 
of an analogous sort to land rent, the possibilities 
of taking them in taxation and the social utility of 
taking them should be separately considered. And 
in the meanwhile, the possibility of there being 
other unearned incomes is no more an adequate ob- 
jection to taxing a kind of incomes we know to be 
unearned, than is the possibility of there being 
gentler ways of stealing, a reason why we should 
allow highway robbery to go on until we have 
reached an agreement about the proper way to 
deal with all forms of dishonesty. Let us not be too 
afraid of a transition period when we may some- 
what discriminate between different sorts of un- 
earned incomes. 

To avoid the objection of infringement on 
"vested rights,'' some advocates of land-value tax- 
ation have proposed that only future increases 



254 Earned and Unearned Incomes. 

in the value of land should be specially taxed. But 
this proposal seems to ignore the fact that pur- 
chasers often pay a higher price for land in the 
expectation of these very future increases. How 
then, can special taxation of these increases be 
anything else than an infringement of "vested 
rights"? In truth, however, too great a respect 
for the "vested rights" of individuals comes peril- 
ously near to meaning no rights for society. It 
might be interpreted to mean that society could 
never modify any policy in the expectation of the 
continuance of which individuals had acted, with- 
out giving compensation. It might be interpreted 
to mean that when we undertake to regulate mo- 
nopoly price, we must compensate the purchasers of 
monopoly stock, and that when we choose to remove 
tariff protection we must compensate holders of 
the stock of protected industries. If society is not 
bound to do these things, neither is it bound to go 
on, through all future time, paying landowners for 
services which not they but nature and society 
render. It may be desirable — as it is certainly al- 
together likely — that any great change should 
be made gradually, but that society, or the non- 
landowning part of society, because it has paid in 
the past for no service received, must either go on 
doing so forever or must buy itself free with no 
expense or loss to landowners, is a doctrine which 
even those who favor it prefer not to state, and 
doubtless will not now state, in all its bareness. 



INDEX 



Abstinence, saving or, in rela- 
tion to interest, 96-107. 

Accumulation, of capital, 78, 79 ; 
versus marginal capital pro- 
ductiveness, 89-96. 

Advertising, as roundabout pro- 
duction, 163, 164. 

Anderson, B. M., Jr., opinion of, 
on quantity theory of money, 
criticized, 35-6n. 

Assessments, on landowners, in 
relation to their right to a 
rental return, 209-212. 

B 

Bank deposits, nature of, 38, 39; 
reserves, change of, in rela- 
tion to interest rates, 147-152. 

Banking, commercial, relation of, 
to the general level of prices, 

38-42- 

Birth control, potential influ- 
ence of, on wages, 186-191- 

Bohm-Bawerk, criticism by, of 
Marshall, criticized, 103 n ; 
criticism of, by Clark, criti- 
cized, 94-5 n ; criticism of, by 
Fisher, criticized, 122, 123 ; 
misinterpretation by, of Car- 
ver, noted, 102 n ; referred to 
as having presented influences 
retarding accumulation, 79n; 
tables of, illustrating advan- 
tage of roundabout produc- 
tion, criticized, 123-4 n; The 
Positi've Theory of Capital, 
cited, 81, 117, 122, 123; Posi- 
tive Theorie des Kapitales, 
Dritte Auflage, cited, 119, 122, 
123, 141. 

Brown, Principles of Commerce, 
cited, 61 n, 73, 150, 183, 197, 
202, 233. 

C 

Capital, the accumulation of, 
78, 79 ; accumulation of, ver- 



(255) 



sus marginal capital produc- 
tiveness, 89-96; cost of pro- 
duction of, in relation to, 70; 
productivity of, 79-88. 

Carver, misinterpretation of, by 
Bohm-Bawerk, noted, 102 n; 
use of terms "demand" and 
"supply" in relation to inter- 
est, cited and criticized, 136; 
The Distribution of Wealth, 
cited, 8i, 102, 175-6 n. 

Cassell, opinion of, regarding di- 
minishing returns to capital in 
relation to law of diminishing 
returns on land, criticized, 91- 
2 n ; use of terms "demand" 
and "supply" in relation to in- 
terest, criticized, 136; The 
Nature and Necessity of In- 
terest, cited, 104, 116, 135. 

Clark, criticism by, of Bohm- 
Bawerk, regarding effect of 
lenthening the production peri- 
od, criticized, 94-5 n ; The 
Distribution of Wealth, cited, 
15, 92, 217. 

Cost, of production, influences de- 
mand for goods as well as 
supply, 54, 55 ; influence of, 
on supply, 59-61 ; labor costs, 
62-66 ; land and capital 
costs, 66-70; land has no cost 
of production, 56, 57. 

D 

Davenport, view of, regarding 
possibility of general oversup- 
ply, discussed, 49-50 n ; Eco- 
nomics of Enterprise, cited, 61, 
98 n, 205 ; Exercises, cited, 
245 ; "Theoretical Issues in 
the Single Tax," cited, 219. 

Demand, and supply, in relation 
to price, 16-28; definition of, 
17, 18; for labor, 172-178; 
for other goods in relation to 



256 



Index 



the supply of one good, 46-50; 
for present goods, 116-125; 
133-137; influence on, of cost 
of production, 54, 55; influ- 
ences back of, 50-57; joint, 
71, 72; relation of, to utility. 

Democracy, classification of in- 
comes as earned and unearn- 
ed a first step in inquiry into 
nature and possibility of eco- 
nomic, 4. 

Deposits, of commercial bank, 
nature of, 38, 39. 

Depression, view of Davenport 
regarding, discussed, 49-50 n. 

Disutility, dependence of supply 
on, 58, 59 ; of labor, in rela- 
tion to amount of labor per- 
formed, 58, 59; marginal, 
53 ; relation of, to utility, 52. 



E 



Ely, view of, regarding relation 
of productivity to interest, 
criticized, 136. 



Factors, of production, 76-78 
Fetter, view, of, that productiv- 
ity theory begs the question, 
criticized, 129. 
Fisher, criticism by, of Bohm- 
Bawerk, criticized, 122, 123 ; 
view of, that all loans are to 
provide present income to 
those desiring the loans, criti- 
cized, 124-129 ; view of, re- 
garding similarity of interest 
and rent, criticized, 203 ; view 
of, regarding abstinence the- 
ory, stated, 103 n ; view of, re- 
garding nature of risk, cited, 
30 n ; Elementary Principles 
of Economics, cited, 65 n; The 
Purchasing Poiver of Money, 
cited, 38, 41, 147, 156; The 
Rate of Interest, cited, 79, 119, 
128, 148, 153, 154- 



G 

George, Progress and Poverty, 
cited, loo, 195 n, 242, 245. 
H 

Hadley, Economics, cited, 214. 
I 

Immigration, in relation to 
wages, 197. 

Impatience, relation of, to rate 
of interest, 11 8-1 37; see, al- 
so, time-preference. 

Incomes, test of earned and un- 
earned, 3, 4, 

Increment, of land values in re- 
lation to the settlement of the 
American West, 217-224; see 
Unearned Increments. 

Increments, of value, taxation of 
future, 235-238; see Unearn- 
ed increments. 

Inheritance, justification of, in 
case of capital produced by 
human labor, 222-223. 

Interest, justification of, com- 
pared with justification of 
wages, 192-194. 

Interest, on capital, comparison 
of land rent with, 203-205 ; 
the causes of, 76-11 1; the 
rate of, 112-170; saving or 
abstinence in relation to, 96- 
107. 

J 

Jevons, The Theory of Political 
Economy, cited, 5, 11, 64, 92 n, 
117, i6i. 

L 

Labor, demand for, 172-178 ; re- 
lation of, to cost of production, 
62-66. 

Land, conditions of supply of, 
distinguished from those of 
most other goods, 61, 62 ; de- 
mand for, not affected, as in 
case of other goods, by possi- 
bility of producing, 55-57; 
distinguished from other goods 
by conditions fixing amount of, 
76-78 ; in relation to cost of 
production, 66-70; rent of, 



Index. 



257 



compared to interest on capi- 
tal, 203-205 ; rent of, as a 
marginal product of land, 199- 
203 ; rent of, as an unearned 
income, 205-208 ; rent of, tax 
on, cannot be shifted, 201- 
203 ; the rent of, and its tax- 
ation, 199-254; the value of, 
70, 71 ; taxation of, in relation 
to the theory of vested rights, 
238-244. 
Landowners, right of, to a re- 
turn on improvements paid for 
by special assessments, 209- 
212; various services of, 
other than paying assessments, 
212-217. 



M 



Marshall, Principles of Econom- 
ics, cited, 72. 

Mill, Principles of Political 
Economy, cited, 73, 98, 173 n. 

Minimum price, of wheat, guar- 
antee of, by United States, 
during war, 14 n. 

Money, use of, in relation to 
rate of interest, 145-147. 

Monopoly, price fixed by, 27, 28 ; 
return to, a case of exploitation 
of consumers, 234. 

O 

Overproduction, possibility of 
general, 47-50. 



Physiocrats, doctrine of, regard- 
ing shifting of taxes, discussed, 
282 n. 

Population, general wages and, 
194-197; limitation of, in cer- 
tain families, in relation to 
right to enjoy land rent, 225- 
229; wages and, 171-198. 

Price, demand and supply in re- 
lation to, 16-28; market, sea- 
sonal and normal, 18, 20; mo- 
nopoly, 27, 28 ; only one in 
a given market at one time, 23, 



24; regulation of, 27, 27-8 n, 
28 ; speculation in relation to. 
28-31. 
Prices, determination of the 
general level of, 31-37; re- 
lation of commercial banking 
to the general level of, 38-42; 
rising and falling, in relation 
to interest, 152-156. 
Production, conditions determin- 
ing extent of an isolated man's, 
10, 11; the factors of, 76- 
78; labor costs in, 62-66; 
land and capital costs in, 66- 
70; measurement of time in- 
volved in roundabout, 116- 
118; possibility of general 
oyer—, 47-50; relative, of 
different goods in relation to 
utility and value, 12-16; 
roundabout, advertising as 
sometimes a case of, 163, 164; 
roundaboutness of, increased 
by the diverting of labor to 
more remote ends, 81-85; 
roundaboutness of, increased 
by the diverting of the factor 
land to more remote ends, 85- 
87; roundaboutness of, in- 
creased by the diverting of 
capital to more remote ends, 
86;^ roundaboutness of, illus- 
trations of ways of increasing, 
87, 88. 

Productiveness, of capital, in re- 
lation to amount of capital ac- 
cumulation, 89-96. 

Productivity, of capital, 79-88; 
of labor, influence of, on 
wages, 183-185. 
R 

Rae, referred to as having de- 
developed theory of accumu- 
lation, 79 n. 

Regulation, of price, 27, 27-8 n, 
28. 

Rent, of land, and its taxation, 
199-254; compared to inter- 
est on capital, 203-205 ; as a 
marginal product of land, 
199-203 ; tax on, cannot be 



258 



Index. 



shifted, 201-203 ; as unearn- 
ed income, 205-208- 

S 

Saving, or abstinence, in rela- 
tion to interest, 96-107. 

Seager, "The Impatience Theory 
or Interest," cited, 125, 131. 
Senior, Outlines of the Science 
of Political Economy, cited, 76, 

lOI. 

Speculation, in relation to price, 
28-31. 

Supply, definition of, 18, 19; de- 
mand and, in relation to price, 
16-28; dependence of, on 
disutility, 58, 59; dependence 
on, of utility, 59; influence 
on, of cost of production, 59- 
6i ; influences back of, 57- 
62 ; joint, 72, 73 ; of one 
good, in relation to demand 
for other goods, 46-50; of 
present goods offered for fu- 
ture goods, 125-137; possi- 
bility of general over — , 47- 
50. 

T 

Taussig, Principles of Econom- 
ics, cited, 72, 236. 

Tax, on land rent, cannot be 
shifted, 201-203. 

Taxation, ability theory of, dis- 
cussed in relation to tax on 
land rent, 247-249 ; of fu- 
ture increments of value, 235- 
238 ; of land values, in rela- 
tion to the theory of vested 
rights, 238-244; the rent of 
land and its, 199-254. 

Time-preference, relation of, to 
rate of interest, 137-145 ; see 
impatience. 

U 
Unearned increments, bearing of 
the contention that there may 



be some not associated with 
land, 230-235; see increment. 
Utility, decline of, with addi- 
tional amounts of a good, 8, 
51; marginal, 52; relation 
of, to demand, 51-53 ; relation 
of, to price, 51, 52; relation 
of, to supply, 59 ; relative pro- 
duction of different goods, 
value and, in a modern com- 
munity, 12-16. 



V 



Value, or analogue of, to isolated 
man, 5-10; the determina- 
tion of, 5-45 ; of land, 70, 
71 ; nature of, 5 ; ultimate 
determinants of, 46-75 ; util- 
ity, relative production of dif- 
ferent goods and, in a modern 
community, 12-16. 

Veblen, view of, regarding usu- 
fruct by capitalists, of imma- 
terial technological equipment 
of the race, criticized, 168 n. 

Vested rights, land value taxa- 
tion in relation to the theory 
of, 238-244. 

W 

Wages, comparative, in different 
labor groups, 185-191 ; popu- 
lation and, 171-198; general, 
and population, 194-197; im- 
migration and, 197; influence 
of productivity of labor on, 
183-185; justification of in- 
terest in relation to justification 
of, 192-194; the proximate 
determination of, 171-183. 

Walker, Political Economy, cited, 
236. 

White, Money and Banking, 
cited, 41. 





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